Basis of property

06 Dec, 2015 TAX LAW 0

Chapter 13
Basis of property

Introduction

The gain or loss you realize on the disposition of property—whether through a sale or exchange—is measured by the difference between the selling price and your basis. In many cases, the basis of an asset is no more than your cost. However, if you acquire property in exchange for services, by inheritance or in exchange for other property, different factors besides cost are likely to have a crucial impact when determining your tax basis.

This chapter tells you how to calculate the basis of property. Particular attention is given to some of the more complicated situations that may arise. You’ll learn, for instance, how to calculate your basis in a particular piece of property by referring to other assets you already hold. To help you determine which expenditures increase your basis in a piece of property and which do not, comprehensive lists of allowable—but often overlooked—expenditures are provided.

This chapter discusses how to figure your basis in property. It is divided into the following sections.

Cost basis.
Adjusted basis.
Basis other than cost.

Your basis is the amount of your investment in property for tax purposes. Use the basis to figure gain or loss on the sale, exchange, or other disposition of property. Also use it to figure deductions for depreciation, amortization, depletion, and casualty losses.

If you use property for both business or investment purposes and for personal purposes, you must allocate the basis based on the use. Only the basis allocated to the business or investment use of the property can be depreciated.

Your original basis in property is adjusted (increased or decreased) by certain events. For example, if you make improvements to the property, increase your basis. If you take deductions for depreciation or casualty losses, or claim certain credits, reduce your basis.

Useful Items

You may want to see:

Publication

15-B Employer’s Tax Guide to Fringe Benefits
525 Taxable and Nontaxable Income
535 Business Expenses
537 Installment Sales
544 Sales and Other Dispositions of Assets
550 Investment Income and Expenses
551 Basis of Assets
946 How To Depreciate Property

Tax Breaks and Deductions You Can Use Checklist

Like-kind exchanges. In general, any gain realized from selling your property must be included in your taxable income. However, if you trade or exchange business or investment property for “like-kind” property—i.e., property of a similar nature or character—you defer any gain in the property you exchanged. Your newly acquired property is considered to be a continuation of the investment in the original property. Therefore, your basis in the new property is generally the same as the basis in the property you traded. For more information, see Nontaxable Exchanges and Like-Kind Exchanges, later.

Identifying specific shares of stock or bonds sold. Keep accurate, detailed records of your tax basis in specific lots of stocks or bonds you purchase. By doing so, you can identify those shares with the highest basis when you sell in order to minimize the amount of gain you will need to recognize. Alternatively, since it is generally to your advantage to make charitable contributions of shares with the lowest basis, your ability to specifically identify such shares will enable you to optimize your tax benefit from donating shares.

Cost Basis

The basis of property you buy is usually its cost. The cost is the amount you pay in cash, debt obligations, other property, or services. Your cost also includes amounts you pay for the following items:

Sales tax,
Freight,
Installation and testing,
Excise taxes,
Legal and accounting fees (when they must be capitalized),
Revenue stamps,
Recording fees, and
Real estate taxes (if you assume liability for the seller).

In addition, the basis of real estate and business assets may include other items.

Loans with low or no interest. If you buy property on a time-payment plan that charges little or no interest, the basis of your property is your stated purchase price minus any amount considered to be unstated interest. You generally have unstated interest if your interest rate is less than the applicable federal rate.

For more information, see Unstated Interest and Original Issue Discount (OID) in Publication 537.

Real Property

Real property, also called real estate, is land and generally anything built on, growing on, or attached to land.

If you buy real property, certain fees and other expenses you pay are part of your cost basis in the property.

Lump sum purchase. If you buy buildings and the land on which they stand for a lump sum, allocate the cost basis among the land and the buildings. Allocate the cost basis according to the respective fair market values (FMVs) of the land and buildings at the time of purchase. Figure the basis of each asset by multiplying the lump sum by a fraction. The numerator is the FMV of that asset and the denominator is the FMV of the whole property at the time of purchase.

Fair market value (FMV). FMV is the price at which the property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the necessary facts. Sales of similar property on or about the same date may be helpful in figuring the FMV of the property.

Assumption of mortgage. If you buy property and assume (or buy the property subject to) an existing mortgage on the property, your basis includes the amount you pay for the property plus the amount to be paid on the mortgage.

Settlement costs. Your basis includes the settlement fees and closing costs you paid for buying the property. (A fee for buying property is a cost that must be paid even if you buy the property for cash.) Do not include fees and costs for getting a loan on the property in your basis.

The following are some of the settlement fees or closing costs you can include in the basis of your property.

Abstract fees (abstract of title fees).
Charges for installing utility services.
Legal fees (including fees for the title search and preparation of the sales contract and deed).
Recording fees.
Survey fees.
Transfer taxes.
Owner’s title insurance.
Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.

Settlement costs do not include amounts placed in escrow for the future payment of items such as taxes and insurance.

The following are some of the settlement fees and closing costs you cannot include in the basis of property.

Casualty insurance premiums.
Rent for occupancy of the property before closing.
Charges for utilities or other services related to occupancy of the property before closing.
Charges connected with getting a loan, such as points (discount points, loan origination fees), mortgage insurance premiums, loan assumption fees, cost of a credit report, and fees for an appraisal required by a lender.
Fees for refinancing a mortgage.

Real estate taxes. If you pay real estate taxes the seller owed on real property you bought, and the seller did not reimburse you, treat those taxes as part of your basis. You cannot deduct them as an expense.

If you reimburse the seller for taxes the seller paid for you, you can usually deduct that amount as an expense in the year of purchase. Do not include that amount in the basis of your property. If you did not reimburse the seller, you must reduce your basis by the amount of those taxes.

Points. If you pay points to get a loan (including a mortgage, second mortgage, line of credit, or a home equity loan), do not add the points to the basis of the related property. Generally, you deduct the points over the term of the loan. For more information on how to deduct points, see chapter 24.

Points on home mortgage. Special rules may apply to points you and the seller pay when you get a mortgage to buy your main home. If certain requirements are met, you can deduct the points in full for the year in which they are paid. Reduce the basis of your home by any seller-paid points.

TAXSAVER

If you pay interest, taxes, and other carrying charges on unimproved and unproductive real estate, but cannot deduct these expenses because you do not itemize your deductions, consider treating them as capital expenditures, which increase your basis and can reduce any gain at the time of sale. This election is made on an annual basis and must be renewed each year that you want to continue capitalizing these costs.

Example

Jane rents an apartment and has few itemized deductions. She borrows money to purchase an unimproved lot in Florida. She incurs $1,000 in interest expense on the borrowed funds and pays $100 in real estate taxes in each of the 5 years she holds the property. If Jane elects to capitalize the interest and taxes, she increases her basis by $5,500 over the 5 years ($1,100 × 5 years).

Adjusted Basis

Before figuring gain or loss on a sale, exchange, or other disposition of property or figuring allowable depreciation, depletion, or amortization, you must usually make certain adjustments (increases and decreases) to the cost basis or basis other than cost (discussed later) of the property. The result is the adjusted basis.

Increases to Basis

Increase the basis of any property by all items properly added to a capital account. Examples of items that increase basis are shown in Table 13-1. These include the items discussed below.

Improvements. Add to your basis in property the cost of improvements having a useful life of more than 1 year, that increase the value of the property, lengthen its life, or adapt it to a different use. For example, improvements include putting a recreation room in your unfinished basement, adding another bathroom or bedroom, putting up a fence, putting in new plumbing or wiring, installing a new roof, or paving your driveway.

TAXSAVER

When you sell your home, your gain or loss is measured by the difference between the price you receive on the sale and your basis. Any improvements you have made will have increased your basis and will now decrease your tax liability. It is important that you keep adequate records of all improvements and selling expenses, including the following:

Replacing the roof
Installing permanent storm windows
Installing new plumbing
Installing a new heating or air-conditioning system
Installing a new furnace
Restoring a rundown house
Landscaping: adding new trees, shrubs, or lawn
Building a swimming pool, tennis court, or sauna
Constructing or improving a driveway
Constructing walks
Constructing patios and decks
Constructing walls
Kitchen or bathroom remodeling, including cost of new appliances
Payment of legal fees stemming from improvements, zoning, and so on
Payment of real estate commissions
Other selling expenses, such as advertising or paying professional fees related to staging your property
Payment of closing costs

It is important to distinguish between expenditures that constitute additions to basis and those that constitute repairs. If the asset is used in a trade or a business, repairs are deductible, but do not increase its basis. If the asset is personal, the costs of repairs are not deductible and do not increase the asset’s basis. For a more complete discussion of this matter, see chapter 9, Rental income and expenses.

As noted by the IRS, your basis in property is reduced by money you receive as a return of capital. See chapter 8, Dividends and other corporate distributions, for further details.

Example

You buy land and a building for $25,000 for use as a parking lot. You pay $3,000 to have the building torn down, and you sell some of the materials you salvage from it for $5,000. You figure your adjusted basis in the property by taking your $25,000 initial cost, adding the $3,000 you spent for tearing down the building, and subtracting the $5,000 you received for the materials you salvaged. Your adjusted basis for the lot is $23,000. The money you received from the sale of the salvaged materials is not income, and the cost of tearing down the building is not deductible.

EXPLANATION

The following costs increase your tax basis:

Interest on debt incurred to finance the construction or production of real property, long-lived personal property with a useful life of 20 years or more, and other tangible property requiring more than 2 years (1 year in the case of property costing more than $1 million) to produce, construct, or reach a productive stage. Additionally, interest incurred to finance property produced under a long-term contract increases your tax basis to the extent that income is not reported under the percentage of completion method. These rules do not apply to interest incurred during the construction of real property to be used as your principal residence or a second home. For a definition of principal residence, see chapter 15, Selling your home. See chapter 24, Interest expense, for other rules affecting how much interest you may be able to deduct on a residence.
The costs of defending or perfecting a title, architect’s fees, and financing and finder’s fees. (Loan origination fees—commonly called “points”—incurred while financing the purchase of a principal residence may be currently deducted in certain circumstances. See chapter 24, Interest expense, for further information.)
Certain start-up and organizational costs for a business. These include costs of investigating the creation or acquisition of an active trade or business, legal fees for the drafting of documents, accounting fees, and other similar expenses directly associated with the organization of a business. The costs of organizing a partnership, such as the expenses incurred in raising capital, putting together a prospectus and paying commissions on the sale of investment units, also increase your basis. See chapter 38, Self-employment income: How to file Schedule C, and Publication 535, Business Expenses, for further information.

Table 13-1. Examples of Adjustments to Basis

Increases to Basis

Decreases to Basis

• Capital improvements:
Putting an addition on your home
Replacing an entire roof
Paving your driveway
Installing central air conditioning
Rewiring your home
• Assessments for local improvements:
Water connections
Extending utility service lines to the property
Sidewalks
Roads
• Casualty losses:
Restoring damaged property
• Legal fees:
Cost of defending and perfecting a title
Fees for getting a reduction of an assessment
• Zoning costs

• Exclusion from income of subsidies for energy conservation measures
• Casualty or theft loss deductions and insurance reimbursements
• Postponed gain from the sale of a home
• Alternative motor vehicle credit (Form 8910)
• Alternative fuel vehicle refueling property credit (Form 8911)
• Residential energy credits (Form 5695)
• Depreciation and Section 179 deduction
• Nontaxable corporate distributions
• Certain canceled debt excluded from
income
• Easements
• Adoption tax benefits

Assessments for local improvements. Add to the basis of property assessments for improvements such as streets and sidewalks if they increase the value of the property assessed. Do not deduct them as taxes. However, you can deduct as taxes assessments for maintenance or repairs, or for meeting interest charges related to the improvements.

Example. Your city changes the street in front of your store into an enclosed pedestrian mall and assesses you and other affected property owners for the cost of the conversion. Add the assessment to your property’s basis. In this example, the assessment is a depreciable asset.

Decreases to Basis

Decrease the basis of any property by all items that represent a return of capital for the period during which you held the property. Examples of items that decrease basis are shown in Table 13-1. These include the items discussed below.

Casualty and theft losses. If you have a casualty or theft loss, decrease the basis in your property by any insurance proceeds or other reimbursement and by any deductible loss not covered by insurance.

You must increase your basis in the property by the amount you spend on repairs that restore the property to its pre-casualty condition.

For more information on casualty and theft losses, see chapter 26.

Depreciation and Section 179 deduction. Decrease the basis of your qualifying business property by any Section 179 deduction you take and the depreciation you deducted, or could have deducted (including any special depreciation allowance), on your tax returns under the method of depreciation you selected.

TAXSAVER

Section 179 of the tax code allows you to deduct all or part of the cost—up to specified yearly limits—of certain qualifying property in the year in which the property is purchased and placed into service, rather than capitalizing the cost and depreciating it over its life. This means that you can deduct all or part of the cost up front in one year rather than taking depreciation deductions spread out over many years. You must decide for each item of qualifying property whether to deduct, subject to the yearly limit, or capitalize and depreciate its cost. Qualifying property is eligible property purchased for use in your trade or business. Eligible property includes tangible personal property (i.e., tangible property that is not real property) and certain other specified tangible property. See Publication 946, How to Depreciate Property, for further information.

Specified limits. The maximum Section 179 deduction available for qualifying property placed into service during 2014 is $25,000 (down from $500,000 in 2013). The allowable deduction is reduced dollar for dollar once the cost of qualifying property placed into service during 2014 exceeds $200,000 (down from $2 million in 2013). Unlike 2013, the definition of Section 179 property does not include certain qualified real qualified leasehold improvement property, qualified restaurant property, or qualified retail improvement property. As of the time this book was published in October 2014, Congress had been considering legislation that would extend the higher limits that expired at the end of 2013 at least through 2014; perhaps even permanently, but no such extension had yet been passed. For updated information on this and any other tax law changes that occur after this book was published, see our website, ey.com/EYTaxGuide.

For more information about depreciation and the Section 179 deduction, see Publication 946 and the Instructions for Form 4562.

Example. You owned a duplex used as rental property that cost you $40,000, of which $35,000 was allocated to the building and $5,000 to the land. You added an improvement to the duplex that cost $10,000. In February last year, the duplex was damaged by fire. Up to that time, you had been allowed depreciation of $23,000. You sold some salvaged material for $1,300 and collected $19,700 from your insurance company. You deducted a casualty loss of $1,000 on your income tax return for last year.

You spent $19,000 of the insurance proceeds for restoration of the duplex, which was completed this year. You must use the duplex’s adjusted basis after the restoration to determine depreciation for the rest of the property’s recovery period. Figure the adjusted basis of the duplex as follows:

Note. Your basis in the land is its original cost of $5,000.

Easements. The amount you receive for granting an easement is generally considered to be proceeds from the sale of an interest in real property. It reduces the basis of the affected part of the property. If the amount received is more than the basis of the part of the property affected by the easement, reduce your basis in that part to zero and treat the excess as a recognized gain.

Only gold members can continue reading. Log In or Register to continue

Fastest Law Search Engine