Publication 225: Farmer's Tax Guide; Basis of Assets

This is archived information that pertains only to the 2003 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.

Table of Contents

Introduction

Basis is the amount of your investment in property for tax purposes. Use the basis of property to figure the gain or loss on the sale, exchange, or other disposition of property. Also use it to figure depreciation, amortization, depletion, and casualty losses. If you use property for both business and personal purposes, you must allocate the basis based on the use. Only the basis allocated to the business use of the property can be depreciated.

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

It is important to keep an accurate record of your basis. For information on keeping records, see chapter 1.

Topics - This chapter discusses:

Useful Items - You may want to see:

The basis of property you buy is usually its cost. Cost is the amount you pay in cash, debt obligations, other property, or services. Your cost includes amounts you pay for sales tax, freight, installation, and testing. The basis of real estate and business assets will include other items. Basis generally does not include interest payments. However, see Carrying charges in chapter 5 of Publication 535.

You also may have to capitalize (add to basis) certain other costs related to buying or producing property. Under the uniform capitalization rules, discussed later, you may have to capitalize direct costs and certain indirect costs of producing property.

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 the amount considered to be unstated interest. You generally have unstated interest if your interest rate is less than the applicable federal rate. See the discussion of unstated interest in Publication 537, Installment Sales.

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.

If you buy improvements, such as buildings, and the land on which they stand for a lump sum, allocate your cost basis between the land and improvements to figure the basis for depreciation of the improvements. Allocate the cost basis according to the respective fair market values of the land and improvements at the time of purchase.

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 usually can 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.

Settlement costs.

You can include in the basis of property you buy the settlement fees and closing costs that are for buying the property. (A fee for buying property is a cost that must be paid even if you bought the property for cash.) You cannot include fees and costs for getting a loan on the property.

The following items 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 title search and preparation of the sales contract and deed).
Recording fees.
Surveys.
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 items are some settlement fees and closing costs you cannot include in the basis of the 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.
Fees for refinancing a mortgage.
Charges connected with getting a loan. The following items are examples of these charges.
1. Mortgage insurance premiums.
2. Loan assumption fees.
3. Cost of a credit report.
4. Fees for an appraisal required by a lender.

If these costs relate to business property, items (1) through (3) are deductible as business expenses. Items (4) and (5) must be capitalized as costs of getting a loan and can be deducted over the period of the loan.

Points.

If you pay points to get a loan (including a mortgage, second mortgage, or line-of-credit), 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 about deducting points, see Points in chapter 5 of Publication 535.

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 the amount of any seller-paid points. For more information, see Points in Publication 936, Home Mortgage Interest Deduction.

Assumption of a mortgage.

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

Example.

If you buy a farm for $100,000 cash and assume a mortgage of $400,000, your basis is $500,000.

Constructing assets.

If you build property or have assets built for you, your expenses for this construction are part of your basis. Some of these expenses include the following items.

Land.
Paid labor and materials.
Architect's fees.
Building permit charges.
Payments to contractors.
Payments for rental equipment.
Inspection fees.

In addition, if you use your employees, farm materials, and equipment to build an asset, your basis would also include the following costs.

Wages paid for the construction work.
Depreciation on equipment you own while it is used in the construction.
Operating and maintenance costs for equipment used in the construction.
Business supplies and materials used in the construction.

Do not deduct these expenses. You must capitalize them (include them in the asset's basis).

Reduce the asset's basis by any of the following credits allowable on the wages you pay in (1).

Empowerment zone and renewal community employment credit.
Indian employment credit.
Welfare-to-work credit.
Work opportunity credit.

For information about these credits, see chapter 9 and Publication 954, Tax Incentives for Distressed Communities.

Do not include the value of your own labor, or any other labor you did not pay for, in the basis of any property you construct.

If you buy multiple assets for a lump sum, allocate the amount you pay among the assets. Use this allocation to figure your basis for depreciation and gain or loss on a later disposition of any of these assets.

Group of assets acquired.

If you buy multiple assets for a lump sum, you and the seller may agree in the sales contract to a specific allocation of the purchase price among the assets. If this allocation is based on the value of each asset and you and the seller have adverse tax interests, the allocation generally will be accepted.

Farming business acquired.

If you buy a group of assets that constitutes a farming business, there are special rules you must use to allocate the purchase price among the assets. See Trade or Business Acquired under Allocating the Basis in Publication 551 for more information.

Transplanted embryo.

If you buy a cow that is pregnant with a transplanted embryo, allocate to the basis of the cow the part of the purchase price equal to the FMV of the cow. Allocate the rest of the purchase price to the basis of the calf. Neither the cost allocated to the cow nor the cost allocated to the calf is deductible as a current business expense.

Quotas and allotments.

Certain areas of the country have quotas or allotments for commodities such as milk, tobacco, and peanuts. The cost of the quota or allotment is its basis. If you acquire a right to a quota with the purchase of land or a herd of dairy cows, allocate part of the purchase price to that right.

Under the uniform capitalization rules, you must capitalize all direct costs and an allocable part of indirect costs incurred due to your production or resale activities. The term capitalize means to include certain expenses in the basis of property you produce or in your inventory costs, rather than claiming them as a current deduction. You recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property.

Activities subject to the rules.

You are subject to the uniform capitalization rules if you do any of the following.

Produce real or tangible personal property.
Acquire property for resale. However, this rule does not apply to personal property if your average annual gross receipts for the three prior tax years are $10 million or less.

You produce property if you construct, build, install, manufacture, develop, improve, or create the property. You produce property if you raise or grow any agricultural or horticultural commodity, including plants and animals. You are not subject to the uniform capitalization rules if the property is produced for personal use.

Generally, you are not required to capitalize the costs of producing animals and certain plants. See Exceptions, later.

The direct and indirect costs of producing plants or animals include preparatory costs and preproductive period costs. Preparatory costs include the acquisition cost of the seed, seedling, plant, or animal. For plants, preproductive period costs include the cost of items such as irrigation, pruning, frost protection, spraying, and harvesting. For animals, preproductive period costs include the cost of items such as feed, maintaining pasture or pen areas, breeding, veterinary services, and bedding.

The term animal includes any stock, poultry or other bird, and fish or other sea life.

Table 7–1. Preproductive Period of More Than 2 Years

Plants producing the following crops or yields have a nationwide weighted average preproductive period of more than 2 years.
Almonds Apples Apricots Avocados Blackberries Blueberries Cherries Chestnuts Coffee beans	Currants Dates Figs Grapefruit Grapes Guavas Kiwifruit Kumquats Lemons Limes	Macadamia nuts Mangoes Nectarines Olives Oranges Papayas Peaches Pears Pecans	Persimmons Pistachio nuts Plums Pomegranates Prunes Raspberries Tangelos Tangerines Tangors Walnuts

Exceptions.

The uniform capitalization rules do not apply to the following.

Any animal.
Any plant with a preproductive period of 2 years or less.
Costs of replanting certain plants lost or damaged due to casualty.

Exceptions (1) and (2) do not apply to a corporation, partnership, or tax shelter required to use an accrual method of accounting. See Accrual method required under Accounting Methods in chapter 3.

In addition, you can choose not to use the uniform capitalization rules in the case of plants with a preproductive period of more than 2 years. If you make this choice, special rules apply. This choice cannot be made by a corporation, partnership, or tax shelter required to use an accrual method of accounting. This choice also does not apply to any costs incurred for the planting, cultivation, maintenance, or development of any citrus or almond grove (or any part thereof) within the first 4 years the trees were planted.

If you chose not to use the uniform capitalization rules, you must use the alternative depreciation system for all property used in any of your farming businesses and placed in service during the election period.

Example.

You grow trees that have a preproductive period of more than 2 years. The trees produce an annual crop. You are an individual and the uniform capitalization rules apply to your farming business. You must capitalize the direct cost and an allocable part of indirect costs incurred due to the production of the trees. You are not required to capitalize the costs of producing the annual crop because its preproductive period is 2 years or less.

Preproductive period of more than 2 years.

The preproductive period of plants grown in commercial quantities in the United States is based on their nationwide weighted average preproductive period. Plants producing the crops or yields shown in Table 7–1 have a preproductive period of more than 2 years. Other plants may also have a preproductive period of more than 2 years.

More information.

For more information on the uniform capitalization rules, see the regulations under section 263A of the Internal Revenue Code. Section 1.263A-4 of the regulations applies to property produced in a farming business.

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 to the basis of the property. The result of these adjustments is the adjusted basis of the property.

Increase the basis of any property by all items properly added to a capital account. These include the cost of improvements having a useful life of more than 1 year.

If you make additions or improvements to business property, keep separate accounts for them. Depreciate the basis of each addition or improvement according to the depreciation rules that would apply to the underlying property if you had placed it in service at the same time you placed the addition or improvement in service. See chapter 8.

Assessments for local improvements.

Increase the basis of property by assessments for items such as paving roads and building ditches that increase the value of the property assessed. Do not deduct them as taxes. However, you can deduct as taxes charges for maintenance, repairs, or interest charges related to the improvements.

Deducting vs. capitalizing costs.

Do not add to your basis costs you can deduct as current expenses. For example, amounts paid for incidental repairs or maintenance are deductible as business expenses and are not added to basis. However, you can choose either to deduct or to capitalize certain other costs. See chapter 8 in Publication 535.

The section 179 deduction.
The deduction for clean-fuel vehicles and clean-fuel vehicle refueling property.
Investment credit (part or all) taken.
Casualty and theft losses and insurance reimbursements.
Amounts you receive for granting an easement.
Deductions previously allowed or allowable for amortization, depreciation, and depletion.
Special depreciation allowance on qualified property.
Exclusion from income of subsidies for energy conservation measures.
Credit for qualified electric vehicles.
Certain canceled debt excluded from income.
Rebates.
Patronage dividends received as a result of a purchase of property. See Patronage Dividends in chapter 4.
Gas-guzzler tax.
Employer-provided childcare credit.

Section 179 deduction.

If you take the section 179 deduction for all or part of the cost of qualifying business property, decrease the basis of the property by the deduction. For more information, see Section 179 Deduction in chapter 8.

Deduction for clean-fuel vehicle and clean-fuel vehicle refueling property.

If you take the deduction for clean-fuel vehicles or clean-fuel vehicle refueling property, decrease the basis of the property by the deduction. For more information, see chapter 12 in Publication 535.

Casualties and thefts.

If you have a casualty or theft loss, decrease the basis of the property by the amount of any insurance or other reimbursement. Also, decrease it by any deductible loss not covered by insurance. See chapter 13 for information about figuring your casualty or theft loss.

You must increase your basis in the property by the amount you spend on repairs that substantially prolong the life of the property, increase its value, or adapt it to a different use. To make this determination, compare the repaired property to the property before the casualty.

Easements.

The amount you receive for granting an easement is usually considered to be from the sale of an interest in the 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. See Easements and rights-of-way in chapter 4.

Depreciation.

Decrease the basis of property by the depreciation you deducted, or could have deducted, on your tax returns under the method of depreciation you chose. If you took less depreciation than you could have or you did not take a depreciation deduction, reduce the basis by the full amount of depreciation you could have taken. If you deducted more depreciation than you should have, decrease your basis by the amount you should have deducted plus the part of the excess depreciation you deducted that actually reduced your tax liability for any year.

See chapter 8 for information on figuring the depreciation you should have claimed. See also Changing Your Accounting Method in chapter 8 for information that may benefit you if you deducted the wrong amount of depreciation.

In decreasing your basis for depreciation, take into account the amount deducted on your tax returns as depreciation and any depreciation you must capitalize under the uniform capitalization rules.

Special depreciation allowance.

Decrease the basis of property by the special depreciation allowance on qualified property. Do not decrease the basis if you made the election not to claim the special depreciation allowance. See chapter 8 for more information on the special depreciation allowance.

Exclusion from income of subsidies for energy conservation measures.

You can exclude from gross income any subsidy you received from a public utility company for the purchase or installation of an energy conservation measure for a dwelling unit. Reduce the basis of the property by the excluded amount.

Credit for qualified electric vehicle.

If you claim the credit for a qualified electric vehicle, you must reduce your basis in that vehicle by the lesser of the following amounts.

$4,000.
10% of the vehicle's cost.

This reduction amount applies even if the credit allowed is less than that amount. For more information on this credit, see chapter 12 in Publication 535.

Canceled debt excluded from income.

If a debt you owe is canceled or forgiven, other than as a gift or bequest, you generally must include the canceled amount in your gross income for tax purposes. A debt includes any indebtedness for which you are liable or which attaches to property you hold.

You can exclude your canceled debt from income if the debt is included in any of the following categories.

Debt canceled in a bankruptcy case or when you are insolvent.
Qualified farm debt.
Qualified real property business debt (provided you are not a C corporation).

If you exclude canceled debt described in (1) or (2), you may have to reduce the basis of your depreciable and nondepreciable property. If you exclude canceled debt described in (3), you must reduce the basis of your depreciable property by the excluded amount.

For more information about canceled debt in a bankruptcy case, see Publication 908, Bankruptcy Tax Guide. For more information about insolvency and canceled debt that is qualified farm debt, see chapter 4. For more information about qualified real property business debt, see chapter 5 in Publication 334, Tax Guide for Small Business.

Employer-provided childcare credit.

If you claim the employer-provided childcare credit for amounts paid or incurred to acquire, construct, rehabilitate, or expand property used as part of your qualified childcare facility, you must reduce your basis in the property by the amount of the credit. For information on the credit, see Form 8882, Credit for Employer-Provided Childcare Facilities and Services.

There are times when you cannot use cost as basis. In these situations, the fair market value or the adjusted basis of property may be used. Adjusted basis was discussed earlier. Fair market value is discussed next.

Fair market value (FMV).

Fair market value (FMV) is the price at which 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 necessary facts. Sales of similar property on or about the same date may help in figuring the FMV of the property.

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 from personal to rental use would be renting out your personal residence.

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.

Property received for services.

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 contrary.

Example.

George Smith is an accountant and also operates a farming business. George agreed to do some accounting work for his neighbor in exchange for a dairy cow. The accounting work and the cow are each worth $1,500. George must include $1,500 in income for his accounting services. George's basis in the cow is $1,500.

A taxable exchange is one in which the gain is taxable, or the loss is deductible. A taxable gain or deductible loss also is known as a recognized gain or loss. A taxable exchange occurs when you receive cash or get property that is not similar or related in use to the property exchanged. If you receive property in exchange for other property in a taxable exchange, the basis of the property you receive is usually its FMV at the time of the exchange.

A nontaxable exchange is an exchange in which you are not taxed on any gain and you cannot deduct any loss. A nontaxable gain or loss also is known as an unrecognized gain or loss. If you receive property in a nontaxable exchange, its basis is usually the same as the basis of the property you transferred.

The exchange of property for the same kind of property is the most common type of nontaxable exchange.

For an 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 chapter 10.

The basis of the property you receive is the same as the basis of the property you gave up.

Exchange expenses.

Exchange expenses generally are the closing costs that you pay. They include such items as brokerage commissions, attorney fees, and deed preparation fees. Add them to the basis of the like-kind property you receive.

Property plus cash.

If you trade property in a like-kind exchange and also pay money, the basis of the property you receive is the basis of the property you gave up plus the money you paid.

Example.

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 cash).

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 unless the loss is not deductible under the related party rules. Each person reports it on the tax return filed for the year in which the later disposition occurred. If this rule applies, the basis of the property received in the original exchange will be its FMV. For more information, see chapter 10.

Exchange of business property.

Exchanging the property of one business for the property of another business is a multiple property exchange. For information on figuring basis, see Multiple Property Exchanges in chapter 1 of Publication 544.

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.

If the other party to the exchange assumes your liabilities, treat the debt assumption as money you received in the exchange.

Example 1.

You trade farmland (basis $10,000) for another tract of farmland (FMV $11,000) and $3,000 cash. You realize a gain of $4,000. This is the FMV of the land received plus the cash minus the basis of the land you traded ($11,000 + $3,000 - $10,000). Include your gain in income (recognize gain) only to the extent of the cash received. Your basis in the land you received is figured as follows.

Basis of land traded	$10,000
Minus: Cash received (adjustment 1(a))	- 3,000
	$7,000
Plus: Gain recognized (adjustment 2(b))	+ 3,000
Basis of land received	$10,000

Example 2.

You trade a truck (adjusted basis $22,750) for another truck (FMV $20,000) and $10,000 cash. You realize a gain of $7,250. This is the FMV of the truck received plus the cash minus the adjusted basis of the truck you traded ($20,000 + $10,000 - $22,750). You include all the gain in your income (recognize gain) because the gain is less than the cash you received. Your basis in the truck you received is figured as follows.

Adjusted basis of truck traded	$22,750
Minus: Cash received (adjustment 1(a))	-10,000
	$12,750
Plus: Gain recognized (adjustment 2(b))	+ 7,250
Basis of truck received	$20,000

Allocation of basis.

If you receive like and unlike properties in the exchange, 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.

Example.

You traded a tractor with an adjusted basis of $15,000 for another tractor that had an FMV of $12,500. You also received $1,000 cash and a truck that had an FMV of $3,000. The truck is unlike property. You realized a gain of $1,500. This is the FMV of the tractor received plus the FMV of the truck received plus the cash minus the adjusted basis of the tractor 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 old tractor	$15,000
Minus: Cash received (adjustment 1(a))	- 1,000
	$14,000
Plus: Gain recognized (adjustment 2(b))	+ 1,500
Total basis of properties received	$15,500

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 tractor.

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.

Example.

You used a tractor on your farm for 3 years. Its adjusted basis is $2,000 and its FMV is $4,000. You are interested in a new tractor, which sells for $15,500. Ordinarily, you would trade your old tractor for the new one and pay the dealer $11,500. Your basis for depreciation for the new tractor would then be $13,500 ($11,500 + $2,000, the basis of your old tractor). However, you want a higher basis for depreciating the new tractor, so you agree to pay the dealer $15,500 for the new tractor if he will pay you $4,000 for your old tractor. Because the two transactions are dependent on each other, you are treated as having exchanged your old tractor for the new one and paid $11,500 ($15,500 - $4,000). Your basis for depreciating the new tractor is $13,500, the same as if you traded the old tractor.

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 converted property.

Similar or related property.

If the replacement property is similar or related in service or use to the converted property, the replacement property's basis is the same as the old property's basis on the date of the conversion. However, make the following adjustments.

Decrease the basis by the following amounts.
1. Any loss you recognize on the involuntary conversion.
2. Any money you receive that you do not spend on similar property.
Increase the basis by the following amounts.
1. Any gain you recognize on the involuntary conversion.
2. 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 replacement property is its cost decreased by the gain not recognized on the involuntary conversion.

For more information about involuntary conversions, see chapter 13.

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. You also must know its FMV at the time it was given to you and any gift tax paid on it.

FMV equal to or more than donor's adjusted basis.

If the FMV of the property is equal to or more than the donor's adjusted basis, your basis is the donor's adjusted basis when 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, earlier.

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 when it was given to you.

Example 1.

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.

Example 2.

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.

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.

Net increase in value of the gift

Amount of the gift

The net increase in value of the gift is the FMV of the gift minus 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 Gift Taxes.

Example.

In 2003, 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 $39,000 ($50,000 minus the $11,000 annual exclusion). She paid a gift tax of $9,000. Your basis, $26,930, is figured as follows.

Fair market value	$50,000
Minus: Adjusted basis	-20,000
Net increase in value	$30,000
Gift tax paid	$9,000
Multiplied by ($30,000 ÷ $39,000)	× .77
Gift tax due to net increase in value	$6,930
Adjusted basis of property to your mother	+20,000
Your basis in the property	$26,930

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 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 get a gain, you have neither gain nor loss on the sale or other disposition of the property.

Example.

You received farmland as a gift from your parents when they retired from farming. At the time of the gift, the land had an FMV of $80,000. Your parents' adjusted basis was $100,000. After you received the land, no events occurred that would increase or decrease your basis.

If you sell the land for $120,000, you will have a $20,000 gain because you must use the donor's adjusted basis at the time of the gift ($100,000) as your basis to figure a gain. If you sell the land for $70,000, you will have a $10,000 loss because you must use the FMV at the time of the gift ($80,000) as your basis to figure a loss.

If the sales price is between $80,000 and $100,000, you have neither gain nor loss. For instance, if the sales price was $90,000 and you tried to figure a gain using the donor's adjusted basis ($100,000), you would get a $10,000 loss. If you then tried to figure a loss using the FMV ($80,000), you would get a $10,000 gain.

Business property.

If you hold the gift as business property, your basis for figuring any depreciation, depletion, or amortization deductions is the same as the donor's adjusted basis plus or minus any required adjustments to basis while you hold the property.

The basis of property transferred to you or transferred in trust for your benefit by your spouse is the same as your spouse's adjusted basis. The same rule applies to a transfer by your former spouse if the transfer is incident to divorce. 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.

The transferor must give you records needed to determine the adjusted basis and holding period of the property as of the date of the transfer.

For more information, see Property Settlements in Publication 504, Divorced or Separated Individuals.

The FMV of the property at the date of the individual's death.
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 Form 706.
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 for Form 706.
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 next.

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.

Special use valuation.

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 at other than its FMV. If so, the executor or personal representative values the qualified real property based on its use as a farm or other closely held business. If the executor or personal representative chooses this method of valuation for estate tax purposes, this 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, 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 on the alternate valuation date. Figure all FMVs without regard to the special-use valuation.

You may be liable for the additional estate tax if, within 10 years after the death of the decedent, you transfer the property or the property stops being used as a farm. This tax may apply if you dispose of the property in a like-kind exchange or involuntary conversion. The tax does not apply if you transfer the property to a member of your family and certain requirements are met. See Form 706–A and its instructions for more information on this tax.

You can elect to increase your basis in special-use valuation property if it becomes subject to the additional estate tax. To increase your basis, 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 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 resulted in the additional estate tax.

You make the election by filing, with Form 706–A, a statement that does all the following.

Contains your (and the estate's) name, address, and taxpayer identification number.
Identifies the election as an election under section 1016(c) of the Internal Revenue Code.
Specifies the property for which you are making the election.
Provides any additional information required by the Form 706–A instructions.

Community property.

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 includible in the decedent's gross estate, whether or not the estate must file a return.

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 also $50,000.

For more information about community property, see Publication 555, Community Property.