There are many times when you cannot use cost as basis. In these
cases, the FMV or the adjusted basis of property may be used. Adjusted
basis is discussed earlier. FMV is discussed next.
Fair market value (FMV).
FMV is the price at which property would change hands between a
buyer and a seller, neither having to buy or sell, and both having
reasonable knowledge of all necessary facts. Sales of similar property
on or about the same date may be helpful in figuring the property's
If you receive property for services, include the property's FMV in
income. The amount you include in income becomes your basis. If the
services were performed for a price agreed on beforehand, it will be
accepted as the FMV of the property if there is no evidence to the
A bargain purchase is a purchase of an item for less than its FMV.
If, as compensation for services, you purchase goods or other property
at less than FMV, include the difference between the purchase price
and the property's FMV in your income. Your basis in the property is
its FMV (your purchase price plus the amount you include in income).
If the difference between your purchase price and the FMV
represents a qualified employee discount do not include the difference
in income. However, your basis in the property is still its FMV. See
Employee Discounts in Publication 15-B,
Employer's Tax Guide to Fringe Benefits.
If you receive property for your services and the property is
subject to certain restrictions, your basis in the property is its FMV
when it becomes substantially vested, unless you make the election
discussed later. Property becomes substantially vested when your
rights in the property or the rights of any person to whom you
transfer the property are not subject to a substantial risk of
There is substantial risk of forfeiture when the rights to full
enjoyment of the property depend on the future performance of
substantial services by any person.
When the property becomes substantially vested, include the FMV,
less any amount you paid for the property, in income.
Your employer gives you stock for services performed under the
condition that you will have to return the stock unless you complete 5
years of service. The stock is under a substantial risk of forfeiture
and is not substantially vested when you receive it. You need not
report any income until you have completed the 5 years of service that
satisfy the condition.
Fair market value.
Figure the FMV of property you received without considering any
restriction except one that by its terms will never end.
For services you performed, you received stock from your employer.
If you want to sell the stock while still employed, you must sell the
stock to your employer at book value. At your retirement or death, you
or your estate must offer to sell the stock to your employer at its
book value. This is a restriction that by its terms will never end and
you consider it when you figure the FMV.
You may choose to include in your gross income the FMV of the
property at the time of transfer, less any amount you paid for it. If
you make this choice, the substantially vested rules do not apply.
Your basis is the amount you paid plus the amount you included in your
See the discussion of Restricted Property in Publication 525
for more information.
A taxable exchange is one in which the gain is taxable or the loss
is deductible. A taxable gain or deductible loss is also known as a
recognized gain or loss. If you receive property in exchange for other
property in a taxable exchange, the basis of property you receive is
usually its FMV at the time of the exchange. A taxable exchange occurs
when you receive cash or get property not similar or related in use to
the property exchanged.
You trade a tract of farm land with an adjusted basis of $3,000 for
a tractor that has an FMV of $6,000. You must report a taxable gain of
$3,000 for the land. The tractor has a basis of $6,000.
If you receive property as a result of an involuntary conversion,
such as a casualty, theft, or condemnation, you may figure the basis
of the replacement property you receive using the basis of the
Similar or related property.
If you receive replacement property similar or related in service
or use to the converted property, the replacement property's basis is
the old property's basis on the date of the conversion. However, make
the following adjustments.
- Decrease the basis by the following.
- Any loss you recognize on the conversion.
- Any money you receive that you do not spend on similar
- Increase the basis by the following.
- Any gain you recognize on the conversion.
- Any cost of acquiring the replacement property.
Money or property not similar or related.
If you receive money or property not similar or related in service
or use to the converted property, and you buy replacement property
similar or related in service or use to the converted property, the
basis of the new property is its cost decreased by the gain not
recognized on the conversion.
The state condemned your property. The property had an adjusted
basis of $26,000, and the state paid you $31,000 for it. You realized
a gain of $5,000 ($31,000 - $26,000). You bought replacement
property similar in use to the converted property for $29,000. You
recognize a gain of $2,000 ($31,000 - $29,000), the unspent part
of the payment from the state. Your gain not recognized is $3,000, the
difference between the $5,000 realized gain and the $2,000 recognized
gain. The basis of the new property is figured as follows:
|Cost of replacement property
|Minus: Gain not recognized
|Basis of the replacement property
Allocating the basis.
If you buy more than one piece of replacement property, allocate
your basis among the properties based on their respective costs.
The state in the previous example condemned your unimproved real
property and the replacement property you bought was improved real
property with both land and buildings. Allocate the replacement
property's $26,000 basis between land and buildings based on their
For more information about condemnations, see Involuntary
Conversions in Publication 544.
For more information about
casualty and theft losses, see Publication 547.
Words you may need to know (see Glossary):
- Intangible property
- Like-class property
- Like-kind property
- Personal property
- Real property
- Tangible property
A nontaxable exchange is an exchange in which you are not taxed on
any gain and you cannot deduct any loss. If you receive property in a
nontaxable exchange, its basis is usually the same as the basis of the
property you transferred. A nontaxable gain or loss is also known as
an unrecognized gain or loss.
The exchange of property for the same kind of property is the most
common type of nontaxable exchange.
To qualify as a like-kind exchange, you must hold for business or
investment purposes both the property you transfer and the property
you receive. There must also be an exchange of like-kind property. For
more information, see Like-Kind Exchanges in Publication 544.
The basis of the property you receive is the same as the basis of
the property you gave up.
You exchange real estate (adjusted basis $50,000, FMV $80,000) held
for investment for other real estate (FMV $80,000) held for
investment. Your basis in the new property is the same as the basis of
the old ($50,000).
Exchange expenses are generally the closing costs you pay. They
include such items as brokerage commissions, attorney fees, deed
preparation fees, etc. Add them to the basis of the like-kind property
Property plus cash.
If you trade property in a like-kind exchange and also pay money,
the basis of the property received is the basis of the property you
gave up increased by the money you paid.
You trade in a truck (adjusted basis $3,000) for another truck (FMV
$7,500) and pay $4,000. Your basis in the new truck is $7,000 (the
$3,000 basis of the old truck plus the $4,000 paid).
Special rules for related persons.
If a like-kind exchange takes place directly or indirectly between
related persons and either party disposes of the property within 2
years after the exchange, the exchange no longer qualifies for
like-kind exchange treatment. Each person must report any gain or loss
not recognized on the original exchange. Each person reports it on the
tax return filed for the year in which the later disposition occurs.
If this rule applies, the basis of the property received in the
original exchange will be its fair market value.
These rules generally do not apply to the following kinds of
- Dispositions due to the death of either related
- Involuntary conversions.
- Dispositions in which neither the original exchange nor the
subsequent disposition had as a main purpose the avoidance of federal
Generally, related persons are ancestors, lineal descendants,
brothers and sisters (whole or half), and a spouse.
For other related persons (for example, two corporations, an
individual and a corporation, a grantor and fiduciary, etc.), see
Nondeductible Loss in chapter 2 of Publication 544.
Exchange of business property.
Exchanging the assets of one business for the assets of another
business is a multiple property exchange. For information on figuring
basis, see Multiple Property Exchanges in chapter 1 in
Partially Nontaxable Exchange
A partially nontaxable exchange is an exchange in which you receive
unlike property or money in addition to like property. The basis of
the property you receive is the same as the basis of the property you
gave up, with the following adjustments.
- Decrease the basis by the following amounts.
- Any money you receive.
- Any loss you recognize on the exchange.
- Increase the basis by the following amounts.
- Any additional costs you incur.
- Any gain you recognize on the exchange.
If the other party to the exchange assumes your liabilities, treat
the debt assumption as money you received in the exchange.
You traded a truck (adjusted basis $6,000) for a new truck (FMV
$5,200) and $1,000 cash. You realized a gain of $200 ($6,200 -
$6,000). This is the FMV of the truck received plus the cash minus the
adjusted basis of the truck you traded ($5,200 + $1,000 -
$6,000). You include all the gain in income (recognized gain) because
the gain is less than the cash received. Your basis in the new truck
|Adjusted basis of old truck
|Minus: Cash received (adjustment 1(a))
|Plus: Gain recognized (adjustment 2(b))
|Basis of new truck
Allocation of basis.
Allocate the basis first to the unlike property, other than money,
up to its FMV on the date of the exchange. The rest is the basis of
the like property.
You had an adjusted basis of $15,000 in real estate you held for
investment. You exchanged it for other real estate to be held for
investment with an FMV of $12,500, a truck with an FMV of $3,000, and
$1,000 cash. The truck is unlike property. You realized a gain of
$1,500 ($16,500 - $15,000). This is the FMV of the real estate
received plus the FMV of the truck received plus the cash minus
the adjusted basis of the real estate you traded ($12,500 + $3,000 +
$1,000 - $15,000). You include in income (recognize) all $1,500
of the gain because it is less than the FMV of the unlike property
plus the cash received. Your basis in the properties you received is
figured as follows.
|Adjusted basis of real estate transferred
|Minus: Cash received (adjustment 1(a))
|Plus: Gain recognized (adjustment 2(b))
|Total basis of properties received
Allocate the total basis of $15,500 first to the unlike property
-- the truck ($3,000). This is the truck's FMV. The rest
($12,500) is the basis of the real estate.
Sale and Purchase
If you sell property and buy similar property in two mutually
dependent transactions, you may have to treat the sale and purchase as
a single nontaxable exchange.
You are a salesperson and you use one of your cars 100% for
business. You have used this car in your sales activities for 2 years
and have depreciated it. Your adjusted basis in the car is $22,600 and
its FMV is $23,100. You are interested in a new car, which sells for
$28,000. If you trade your old car and pay $4,900 for the new one,
your basis for depreciation for the new car would be $27,500 ($4,900
plus the $22,600 basis of your old car). However, you want a higher
basis for depreciating the new car, so you agree to pay the dealer
$28,000 for the new car if he will pay you $23,100 for your old car.
Because the two transactions are dependent on each other, you are
treated as having exchanged your old car for the new one and paid
$4,900 ($28,000 - $23,100). Your basis for depreciating the new
car is $27,500, the same as if you traded the old car.
Partial Business Use of Property
If you have property used partly for business and partly for
personal use, and you exchange it in a nontaxable exchange for
property to be used wholly or partly in your business, the basis of
the property you receive is figured as if you had exchanged two
properties. The first is an exchange of like-kind property. The second
is personal-use property on which gain is recognized and loss is not
First, figure your adjusted basis in the property as if you
transferred two separate properties. Figure the adjusted basis of each
part of the property by taking into account any adjustments to basis.
Deduct the depreciation you took or could have taken from the adjusted
basis of the business part. Then figure the amount realized for your
property and allocate it to the business and nonbusiness parts of the
The business part of the property is permitted to be exchanged tax
free. However, recognize any gain from the exchange of the nonbusiness
part. You are deemed to have received, in exchange for the nonbusiness
part, an amount equal to its FMV on the date of the exchange. The
basis of the property you acquired is the total basis of the property
transferred (adjusted to the date of the exchange), increased by any
gain recognized on the nonbusiness part.
If the nonbusiness part of the property transferred is your main
home, you may qualify to exclude from income all or part of the gain
on that part. For more information, see Publication 523.
Traded car used partly in business.
If you trade in a car that you used partly in your business for
another car that you will use in your business, your basis for
depreciating the new car is not the same as your basis for figuring a
gain or loss on its sale.
For information on figuring your basis for depreciation, see
From a Spouse
The basis of property transferred to you or transferred in trust
for your benefit by your spouse (or former spouse if the transfer is
incident to divorce), is the same as your spouse's adjusted basis.
However, adjust your basis for any gain recognized by your spouse or
former spouse on property transferred in trust. This rule applies only
to a transfer of property in trust in which the liabilities assumed,
plus the liabilities to which the property is subject, are more than
the adjusted basis of the property transferred.
If the property transferred to you is a series E, series EE, or
series I United States savings bond, the transferor must include in
income the interest accrued to the date of transfer. Your basis in the
bond immediately after the transfer is equal to the transferor's basis
increased by the interest income includable in the transferor's
income. For more information on these bonds, see Publication 550.
The transferor must give you, at the time of the transfer, the
records necessary to determine the adjusted basis and holding period
of the property as of the date of transfer.
For more information, see Publication 504,
Received as a Gift
To figure the basis of property you receive as a gift, you must
know its adjusted basis (defined earlier) to the donor just before it
was given to you, its FMV at the time it was given to you, and any
gift tax paid on it.
FMV Less Than
Donor's Adjusted Basis
If the FMV of the property at the time of the gift is less than the
donor's adjusted basis, your basis depends on whether you have a gain
or a loss when you dispose of the property. Your basis for figuring
gain is the same as the donor's adjusted basis plus or minus any
required adjustment to basis while you held the property. Your basis
for figuring loss is its FMV when you received the gift plus or minus
any required adjustment to basis while you held the property (see
Adjusted Basis, earlier).
If you use the donor's adjusted basis for figuring a gain and get a
loss, and then use the FMV for figuring a loss and have a gain, you
have neither gain nor loss on the sale or disposition of the property.
You received an acre of land as a gift. At the time of the gift,
the land had an FMV of $8,000. The donor's adjusted basis was $10,000.
After you received the land, no events occurred to increase or
decrease your basis. If you sell the land for $12,000, you will have a
$2,000 gain because you must use the donor's adjusted basis ($10,000)
at the time of the gift as your basis to figure gain. If you sell the
land for $7,000, you will have a $1,000 loss because you must use the
FMV ($8,000) at the time of the gift as your basis to figure a loss.
If the sales price is between $8,000 and $10,000, you have neither
gain nor loss. For instance, if the sales price was $9,000 and you
tried to figure a gain using the donor's adjusted basis ($10,000), you
would get a $1,000 loss. If you then tried to figure a loss using the
FMV ($8,000), you would get a $1,000 gain.
If you hold the gift as business property, your basis for figuring
any depreciation, depletion, or amortization deduction is the same as
the donor's adjusted basis plus or minus any required adjustments to
basis while you hold the property.
FMV Equal to or More Than
Donor's Adjusted Basis
If the FMV of the property is equal to or greater than the donor's
adjusted basis, your basis is the donor's adjusted basis at the time
you received the gift. Increase your basis by all or part of any gift
tax paid, depending on the date of the gift.
Also, for figuring gain or loss from a sale or other disposition of
the property, or for figuring depreciation, depletion, or amortization
deductions on business property, you must increase or decrease your
basis (the donor's adjusted basis) by any required adjustments to
basis while you held the property. See Adjusted Basis,
Gift received before 1977.
If you received a gift before 1977, increase your basis in the gift
(the donor's adjusted basis) by any gift tax paid on it. However, do
not increase your basis above the FMV of the gift at the time it was
given to you.
You were given a house in 1976 with an FMV of $21,000. The donor's
adjusted basis was $20,000. The donor paid a gift tax of $500. Your
basis is $20,500, the donor's adjusted basis plus the gift tax paid.
If, in Example 1, the gift tax paid had been $1,500, your basis
would be $21,000. This is the donor's adjusted basis plus the gift tax
paid, limited to the FMV of the house at the time you received the
Gift received after 1976.
If you received a gift after 1976, increase your basis in the gift
(the donor's adjusted basis) by the part of the gift tax paid on it
that is due to the net increase in value of the gift. Figure the
increase by multiplying the gift tax paid by the following fraction.
The numerator is the net increase in value of the gift and the
denominator is the amount of the gift.
The net increase in value of the gift is the FMV of the gift less
the donor's adjusted basis. The amount of the gift is its value for
gift tax purposes after reduction by any annual exclusion and marital
or charitable deduction that applies to the gift. For information on
the gift tax, see Publication 950,
Introduction to Estate and
In 2000, you received a gift of property from your mother that had
an FMV of $50,000. Her adjusted basis was $20,000. The amount of the
gift for gift tax purposes was $40,000 ($50,000 minus the $10,000
annual exclusion). She paid a gift tax of $9,000. Your basis, $26,750,
is figured as follows:
|Fair market value
|Minus: Adjusted basis
|Net increase in value
|Gift tax paid
|Multiplied by ($30,000 × $40,000)
|Gift tax due to net increase in value
|Adjusted basis of property to your mother
|Your basis in the property
Your basis in property you inherit from a decedent is generally one
of the following.
- The FMV of the property at the date of the individual's
- The FMV on the alternate valuation date, if the personal
representative for the estate chooses to use alternate valuation. For
information on the alternate valuation date, see the instructions for
- The value under the special-use valuation method for real
property used in farming or other closely held business, if chosen for
estate tax purposes. This method is discussed later.
- The decedent's adjusted basis in land to the extent of the
value that is excluded from the decedent's taxable estate as a
qualified conservation easement. For information on a qualified
conservation easement see the instructions to Form 706.
If a federal estate tax return does not have to be filed, your
basis in the inherited property is its appraised value at the date of
death for state inheritance or transmission taxes.
The above rule does not apply to appreciated property you receive
from a decedent if you or your spouse originally gave the property to
the decedent within 1 year before the decedent's death. Your basis in
this property is the same as the decedent's adjusted basis in the
property immediately before his or her death, rather than its FMV.
Appreciated property is any property whose FMV on the day it was given
to the decedent is more than its adjusted basis.
In community property states (Arizona, California, Idaho,
Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin),
husband and wife are each usually considered to own half the community
property. When either spouse dies, the total value of the community
property, even the part belonging to the surviving spouse, generally
becomes the basis of the entire property. For this rule to apply, at
least half the value of the community property interest must be
includable in the decedent's gross estate, whether or not the estate
must file a return.
For example, you and your spouse owned community property that had
a basis of $80,000. When your spouse died, half the FMV of the
community interest was includible in your spouse's estate. The FMV of
the community interest was $100,000. The basis of your half of the
property after the death of your spouse is $50,000 (half of the
$100,000 FMV). The basis of the other half to your spouse's heirs is
For more information on community property, see Publication 555,
Property Held by Surviving Tenant
The following example explains the rule for the basis of property
held by a surviving tenant in a joint tenancy or tenancy by the
John and Jim owned, as joint tenants with right of survivorship,
business property that they purchased for $30,000. John furnished
two-thirds of the purchase price and Jim furnished one-third.
Depreciation deductions allowed before John's death were $12,000.
Under local law, each had a half interest in the income from the
property. At the date of John's death, the property had an FMV of
$60,000, two-thirds of which is includable in John's estate. Jim
figures his basis in the property at the date of John's death as
|Interest Jim bought with his own funds-- 1/3 of $30,000 cost
|Interest Jim received on John's death-- 2/3 of $60,000 FMV
|Minus: 1/2 of $12,000 depreciation
before John's death
|Jim's basis at the date of John's death
If Jim had not contributed any part of the purchase price, his
basis at the date of John's death would be $54,000. This is figured by
subtracting from the $60,000 FMV, the $6,000 depreciation allocated to
Jim's half interest before the date of death.
If, under local law, Jim had no interest in the income from the
property and if he contributed no part of the purchase price, his
basis at John's death would be $60,000. This $60,000 is the FMV of the
Qualified Joint Interest
Include one-half of the value of a qualified joint interest in the
decedent's gross estate. It does not matter how much each spouse
contributed to the purchase price. Also, it does not matter which
spouse dies first.
A qualified joint interest is any interest in property held by
husband and wife as either of the following.
- Tenants by the entirety.
- Joint tenants with right of survivorship, if husband and
wife are the only joint tenants.
As the surviving spouse, your basis in property that you owned with
your spouse as a qualified joint interest is the cost of your half of
the property with some adjustments. Decrease the cost by any
deductions allowed to you for depreciation and for depletion. Increase
the reduced cost by your basis in the half you inherited.
Farm or Closely Held Business
Under certain conditions, when a person dies the executor or
personal representative of that person's estate may choose to value
the qualified real property on other than its FMV. If so, the executor
or personal representative values the qualified real property based on
its use as a farm or its use in a closely held business. If the
executor or personal representative chooses this method of valuation
for estate tax purposes, that value is the basis of the property for
the heirs. The qualified heirs should be able to get the necessary
value from the executor or personal representative of the estate.
If you are a qualified heir who received special-use valuation
property, your basis in the property is the estate's or trust's basis
in that property immediately before the distribution. Increase your
basis by any gain recognized by the estate or trust because of
post-death appreciation. Post-death appreciation is the property's FMV
on the date of distribution minus the property's FMV either on the
date of the individual's death or the alternate valuation date. Figure
all FMVs without regard to the special-use valuation.
You can elect to increase your basis in special-use valuation
property if it becomes subject to the additional estate tax. This tax
is assessed if, within 10 years after the death of the decedent, you
transfer the property to a person who is not a member of your family
or the property stops being used as a farm or in a closely held
To increase your basis in the property, you must make an
irrevocable election and pay interest on the additional estate tax
figured from the date 9 months after the decedent's death until the
date of the payment of the additional estate tax. If you meet these
requirements, increase your basis in the property to its FMV on the
date of the decedent's death or the alternate valuation date. The
increase in your basis is considered to have occurred immediately
before the event that results in the additional estate tax.
You make the election by filing with Form 706-A a statement that
does all of the following.
- Contains your (and the estate's) name, address, and taxpayer
- Identifies the election as an election under section 1016(c)
of the Internal Revenue Code.
- Specifies the property for which the election is
- Provides any additional information required by the Form
For more information, see the instructions for Form 706 and Form
Property Changed to
Business or Rental Use
When you hold property for personal use and change it to business
use or use it to produce rent, you must figure its basis for
depreciation. An example of changing property held for personal use to
business use would be renting out your former main home.
Basis for depreciation.
The basis for depreciation is the lesser of the following amounts.
- The FMV of the property on the date of the change.
- Your adjusted basis on the date of the change.
Several years ago you paid $160,000 to have your home built on a
lot that cost you $25,000. Before changing the property to rental use
last year, you paid $20,000 for permanent improvements to the house
and claimed a $2,000 casualty loss deduction for damage to the house.
Because land is not depreciable, you can only include the cost of the
house when figuring the basis for depreciation.
Your adjusted basis in the house when you changed its use was
$178,000 ($160,000 + $20,000 - $2,000). On the same date, your
property has an FMV of $180,000, of which $15,000 is for the land and
$165,000 is for the house. The basis for figuring depreciation on the
house is its FMV on the date of change ($165,000), because it is less
than your adjusted basis ($178,000).
Sale of property.
If you later sell or dispose of the property, the basis of the
property you use will depend on whether you are figuring gain or loss.
The basis for figuring a gain is your adjusted basis when you sell
Assume the same facts as in the previous example except that you
sell the property at a gain after being allowed depreciation
deductions of $37,500. Your adjusted basis for figuring gain is
$165,500 ($178,000 + $25,000 (land) - $37,500).
Figure the basis for a loss starting with the smaller of your
adjusted basis or the FMV of the property at the time of the change to
business or rental use. Then adjust this amount for the period after
the change in the property's use, as discussed earlier under
Adjusted Basis, to arrive at a basis for loss.
Assume the same facts as in the previous example, except that you
sell the property at a loss after being allowed depreciation
deductions of $37,500. In this case, you would start with the FMV on
the date of the change to rental use ($180,000), because it is less
than the adjusted basis of $203,000 ($178,000 + $25,000) on that date.
Reduce that amount ($180,000) by the depreciation deductions to arrive
at a basis for loss of $142,500 ($180,000-$37,500).