Basis represents a taxpayer’s investment in property for tax purposes. It determines gain or loss on disposition and affects deductions for depreciation, amortization, depletion, and casualty losses.
When property is used partly for business or investment and partly for personal purposes, basis must be allocated. Only the business/investment portion is depreciable.
Cost Basis
Cost basis generally includes:
- Purchase price
- Commissions
- Sales tax, freight, installation, testing
- Legal and accounting fees (when capitalized)
- Excise taxes, recording fees, transfer taxes
- Real estate taxes assumed from seller
Basis increases with capital improvements and decreases with depreciation, casualty losses, and certain credits.
Real Property Basis
Real property includes land and anything built on or attached to it.
Allocation Between Land and Building
When purchased for a lump sum, allocate basis between land and building using FMV ratios. Land is not depreciable, so allocation is required before computing depreciation.
Settlement Costs Added to Basis
Add:
- Abstract fees
- Utility installation charges
- Title search and deed prep fees
- Recording fees
- Survey fees
- Transfer taxes
- Owner’s title insurance
- Amounts paid on behalf of seller (back taxes, repairs, commissions)
Do not add:
- Casualty insurance
- Pre‑closing rent
- Utilities before closing
- Loan‑related fees (points, origination, mortgage insurance, appraisal)
- Escrow deposits
Points
Points are prepaid interest. They:
- Do not increase basis
- May be deductible in full for a primary home if requirements are met
- Must reduce basis if seller‑paid
Adjusted Basis
Adjusted basis = original basis + capital improvements + assessments for local improvements − depreciation − casualty losses − non‑taxable returns of capital − easement payments − certain credits
Property Received for Services
If property is received as compensation:
- Include FMV in income
- FMV becomes basis
If subject to restrictions, basis is FMV when substantially vested unless the taxpayer elects to include FMV at transfer.
Depreciation Overview
Depreciation applies to:
- Property owned
- Used in a business or income‑producing activity
- With a determinable useful life
- Expected to last more than one year
Depreciation begins when property is placed in service.
Methods of Cost Recovery
- Depreciation — tangible property
- Depletion — natural resources
- Amortization — intangible assets
Repairs vs. Improvements
- Repairs — deductible; keep property in ordinary condition
- Improvements — capitalized; increase value, extend life, or adapt to new use
Examples of improvements: new roof, wiring, plumbing, HVAC, additions, landscaping, fencing.
Safe Harbors
- Small taxpayer safe harbor — may deduct improvements if total expenditures ≤ lesser of $10,000 or 2% of building’s unadjusted basis
- De minimis safe harbor — deduct items ≤ $2,500 per invoice (≤ $5,000 with AFS)
- Materials and supplies — items costing ≤ $200
Eight building systems must always be capitalized: HVAC, plumbing, electrical, escalators, elevators, fire protection/alarm, security, gas distribution.
Bargain Purchases
If property is purchased below FMV as compensation:
- Include FMV − purchase price in income
- Basis = FMV
Involuntary Conversions
For replacement property similar in service or use:
- Basis = old basis
- − loss recognized
- − unspent reimbursement
- + gain recognized
- + cost of replacement
If replacement property is purchased after receiving money or dissimilar property, basis = cost − unrecognized gain.
Property Received as a Gift
Basis depends on FMV vs. donor’s adjusted basis.
FMV < Donor’s Basis (Dual Basis Rule)
- Gain basis = donor’s basis
- Loss basis = FMV at date of gift
- No gain/loss if sale price falls between FMV and donor’s basis
FMV ≥ Donor’s Basis
- Basis = donor’s basis
- Increase basis by portion of gift tax attributable to appreciation
Holding period:
- Uses donor’s holding period when donor’s basis applies
- Starts day after gift when FMV basis applies
Property Transferred Between Spouses
Transfers between spouses or incident to divorce:
- No gain or loss recognized
- Basis and holding period carry over
Inherited Property
Inherited property generally receives FMV basis at date of death or alternate valuation date (if elected).
Gain is always long‑term.
Exception
No step‑up if:
- Property was gifted to the decedent by the heir within one year of death
- Basis = decedent’s adjusted basis
Ownership Forms
- Qualified joint interest (married couple) → step‑up on ½
- JTWROS → step‑up only on portion included in decedent’s estate
- Community property → 100% step‑up if decedent’s share is in the estate
Property Converted from Personal to Business Use
When converting personal property to business or rental use:
- Depreciation basis = lower of:
- FMV at time of conversion
- Adjusted basis