| Pub. 551, Basis of Assets |
2005 Tax Year |
Publication 551 - Main Contents
Terms you may need to know (see Glossary):
| Business assets |
| Real property |
| Unstated interest |
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).
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Revenue stamps.
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Recording fees.
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Real estate taxes (if assumed for the seller).
You may also have to capitalize certain other costs related to buying or 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.
Purchase of a business.
When you purchase a trade or business, you generally purchase all assets used in the business operations, such as
land, buildings, and machinery.
Allocate the price among the various assets including any section 197 intangibles. See Allocating the Basis, later.
The basis of stocks or bonds you buy is generally the purchase price plus any costs of purchase, such as commissions and recording
or transfer
fees. If you get stocks or bonds other than by purchase, your basis is usually determined by the fair market value (FMV) or
the previous owner's
adjusted the basis of stock.
You must adjust the basis of stocks for certain events that occur after purchase. See Stocks and Bonds in chapter 4 of Publication 550
for more information on the basis of stock.
Identifying stock or bonds sold.
If you can adequately identify the shares of stock or the bonds you sold, their basis is the cost or other basis of
the particular shares of stock
or bonds. If you buy and sell securities at various times in varying quantities and you cannot adequately identify the shares
you sell, the basis of
the securities you sell is the basis of the securities you acquired first. For more information about identifying securities
you sell, see Stocks
and Bonds under Basis of Investment Property in chapter 4 of Publication 550.
Mutual fund shares.
If you sell mutual fund shares acquired at different times and prices, you can choose to use an average basis. For
more information, see
Average Basis in Publication 564.
If you buy real property, certain fees and other expenses become part of your cost basis in the property.
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 taxes.
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 the 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 for buying the property. You
cannot include fees and costs
for getting a loan on the property. (A fee for buying property is a cost that must be paid even if you bought the property
for cash.)
The following items are some of the settlement fees or closing costs you can include in the basis of your property.
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Abstract fees (abstract of title fees).
-
Charges for installing utility services.
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Legal fees (including title search and preparation of the sales contract and deed).
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Recording fees.
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Surveys.
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Transfer taxes.
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Owner's title insurance.
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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.
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Fire insurance premiums.
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Rent for occupancy of the property before closing.
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Charges for utilities or other services related to occupancy of the property before closing.
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Charges connected with getting a loan. The following are examples of these charges.
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Points (discount points, loan origination fees).
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Mortgage insurance premiums.
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Loan assumption fees.
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Cost of a credit report.
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Fees for an appraisal required by a lender.
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Fees for refinancing a mortgage.
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 obtain 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
Points in chapter 5 of Publication 535.
Points on home mortgage.
Special rules may apply to points you and the seller pay when you obtain a mortgage to purchase 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.
For more information,
see Points in Publication 936, Home Mortgage Interest Deduction.
Assumption of mortgage.
If you buy property and assume (or buy 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.
Example.
If you buy a building for $20,000 cash and assume a mortgage of $80,000 on it, your basis is $100,000.
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.
In addition, if you own a business and use your employees, material, and equipment to build an asset, your basis would also
include the
following costs.
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Employee wages paid for the construction work.
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Depreciation on equipment you own while it is used in the construction.
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Operating and maintenance costs for equipment used in the construction.
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The cost of business supplies and materials used in the construction.
Do not deduct these expenses. You must capitalize them (include them in the asset's basis). Also, reduce your basis by any
work opportunity
credit, welfare-to-work credit, Indian employment credit, or empowerment zone employment credit allowable on the wages you
pay in (1), above. For
information about these credits, see Publication 954, Tax Incentives for Empowerment Zones and Other 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.
Terms you may need to know (see Glossary):
| Amortization |
| Capitalization |
| Depletion |
| Depreciation |
| Fair market value |
| Going concern value |
| Goodwill |
| Intangible property |
| Personal property |
| Recapture |
| Section 179 deduction |
| Section 197 intangibles |
| Tangible property |
If you purchase property to use in your business, your basis is usually its actual cost to you. If you construct, create,
or otherwise produce
property, you must capitalize the costs as your basis. In certain circumstances, you may be subject to the uniform capitalization
rules, next.
Uniform Capitalization Rules
The uniform capitalization rules specify the costs you add to basis in certain circumstances.
Activities subject to the rules.
You must use the uniform capitalization rules if you do any of the following in your trade or business or activity
carried on for profit.
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Produce real or tangible personal property for use in the business or activity.
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Produce real or tangible personal property for sale to customers.
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Acquire property for resale.
You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow the property.
Treat property produced
for you under a contract as produced by you up to the amount you pay or costs you otherwise incur for the property. Tangible
personal property
includes films, sound recordings, video tapes, books, or similar property.
Under the uniform capitalization rules, you must capitalize all direct costs and an allocable part of most
indirect costs you incur 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 deduct them as a current expense. You recover these costs through
deductions for
depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property.
Any cost you cannot use to figure your taxable income for any tax year is not subject to the uniform capitalization
rules.
Example.
If you incur a business meal expense for which your deduction would be limited to 50% of the cost of the meal, that amount
is subject to the
uniform capitalization rules. The nondeductible part of the cost is not subject to the uniform capitalization rules.
More information.
For more information about these rules, see the regulations under section 263A of the Internal Revenue Code and Publication
538, Accounting
Periods and Methods.
Exceptions.
The following are not subject to the uniform capitalization rules.
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Property you produce that you do not use in your trade, business, or activity conducted for profit.
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Qualified creative expenses you pay or incur as a free-lance (self-employed) writer, photographer, or artist that are otherwise
deductible
on your tax return.
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Property you produce under a long-term contract, except for certain home construction contracts.
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Research and experimental expenses allowable as a deduction under section 174 of the Internal Revenue Code.
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Costs for personal property acquired for resale if your (or your predecessor's) average annual gross receipts for the 3 previous
tax years
do not exceed $10 million.
For other exceptions to the uniform capitalization rules, see section 1.263A-1(b) of the regulations.
For information on the special rules that apply to costs incurred in the business of farming, see chapter 7 of Publication
225, Farmer's Tax
Guide.
Intangible assets include goodwill, patents, copyrights, trademarks, trade names, and franchises. The basis of an intangible
asset is usually the
cost to buy or create it. If you acquire multiple assets, for example a going business for a lump sum, see Allocating the Basis, later, to
figure the basis of the individual assets. The basis of certain intangibles can be amortized. See chapter 9 of Publication
535 for information on the
amortization of these costs.
Patents.
The basis of a patent you get for an invention is the cost of development, such as research and experimental expenditures,
drawings, working
models, and attorneys' and governmental fees. If you deduct the research and experimental expenditures as current business
expenses, you cannot
include them in the basis of the patent. The value of the inventor's time spent on an invention is not part of the basis.
Copyrights.
If you are an author, the basis of a copyright will usually be the cost of getting the copyright plus copyright fees,
attorneys' fees, clerical
assistance, and the cost of plates that remain in your possession. Do not include the value of your time as the author, or
any other person's time you
did not pay for.
Franchises, trademarks, and trade names.
If you buy a franchise, trademark, or trade name, the basis is its cost, unless you can deduct your payments as a
business expense.
If you buy multiple assets for a lump sum, allocate the amount you pay among the assets you receive. You must make this allocation
to figure your
basis for depreciation and gain or loss on a later disposition of any of these assets. See Trade or Business Acquired, later.
If you buy multiple assets for a lump sum, you and the seller may agree to a specific allocation of the purchase price among
the assets in the
sales contract. 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. However, see Trade or Business Acquired, next.
Trade or Business Acquired
If you acquire a trade or business, allocate the consideration paid to the various assets acquired. Generally, reduce the
consideration paid by any
cash and general deposit accounts (including checking and savings accounts) received. Allocate the remaining consideration
to the other business
assets received in proportion to (but not more than) their fair market value in the following order.
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Certificates of deposit, U.S. Government securities, foreign currency, and actively traded personal property, including stock
and
securities.
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Accounts receivable, other debt instruments, and assets you mark to market at least annually for federal income tax purposes.
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Property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held primarily
for sale to
customers in the ordinary course of business.
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All other assets except section 197 intangibles, goodwill, and going concern value.
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Section 197 intangibles except goodwill and going concern value.
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Goodwill and going concern value (whether or not they qualify as section 197 intangibles).
Agreement.
The buyer and seller may enter into a written agreement as to the allocation of any consideration or the fair market
value (FMV) of any of the
assets. This agreement is binding on both parties unless the IRS determines the amounts are not appropriate.
Reporting requirement.
Both the buyer and seller involved in the sale of business assets must report to the IRS the allocation of the sales
price among section 197
intangibles and the other business assets. Use Form 8594 to provide this information. The buyer and seller should each attach Form 8594 to
their federal income tax return for the year in which the sale occurred.
More information.
See Sale of a Business in chapter 2 of Publication 544 for more information.
If you buy buildings and the land on which they stand for a lump sum, allocate the basis of the property among the land and
the buildings so you
can figure the depreciation allowable on the buildings.
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. If you are not certain of the FMV of the land and buildings, you can allocate
the basis based on their
assessed values for real estate tax purposes.
Demolition of building.
Add demolition costs and other losses incurred for the demolition of any building to the basis of the land on which
the demolished building was
located. Do not claim the costs as a current deduction.
Modification of building.
A modification of a building will not be treated as a demolition if the following conditions are satisfied.
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75 percent or more of the existing external walls of the building are retained in place as internal or external walls.
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75 percent or more of the existing internal structural framework of the building is retained in place.
If the building is a certified historic structure, the modification must also be part of a certified rehabilitation.
If these conditions are met, add the costs of the modifications to the basis of the building.
Subdivided lots.
If you buy a tract of land and subdivide it, you must determine the basis of each lot. This is necessary because you
must figure the gain or loss
on the sale of each individual lot. As a result, you do not recover your entire cost in the tract until you have sold all
of the lots.
To determine the basis of an individual lot, multiply the total cost of the tract by a fraction. The numerator is
the FMV of the lot and the
denominator is the FMV of the entire tract.
Future improvement costs.
If you are a developer and sell subdivided lots before the development work is completed, you can (with IRS consent)
include in the basis of the
properties sold an allocation of the estimated future cost for common improvements. See Revenue Procedure 92–29 for more information,
including
an explanation of the procedures for getting consent from the IRS.
Use of erroneous cost basis.
If you made a mistake in figuring the cost basis of subdivided lots sold in previous years, you cannot correct the
mistake for years for which the
statute of limitations (generally 3 tax years) has expired. Figure the basis of any remaining lots by allocating the correct
original cost basis of
the entire tract among the original lots.
Example.
You bought a tract of land to which you assigned a cost of $15,000. You subdivided the land into 15 building lots of equal
size and equitably
divided your basis so that each lot had a basis of $1,000. You treated the sale of each lot as a separate transaction and
figured gain or loss
separately on each sale.
Several years later you determine that your original basis in the tract was $22,500 and not $15,000. You sold eight lots using
$8,000 of basis in
years for which the statute of limitations has expired. You now can take $1,500 of basis into account for figuring gain or
loss only on the sale of
each of the remaining seven lots ($22,500 basis divided among all 15 lots). You cannot refigure the basis of the eight lots
sold in tax years barred
by the statute of limitations.
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 to the basis is the
adjusted basis.
Increase the basis of any property by all items properly added to a capital account. These include the cost of any improvements
having a useful
life of more than 1 year.
Rehabilitation expenses also increase basis. However, you must subtract any rehabilitation credit allowed for these expenses
before you add them to
your basis. If you have to recapture any of the credit, increase your basis by the recaptured amount.
If you make additions or improvements to business property, keep separate accounts for them. Also, you must depreciate the
basis of each 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. For more information, see Publication 946.
The following items increase the basis of property.
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The cost of extending utility service lines to the property.
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Impact fees.
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Legal fees, such as the cost of defending and perfecting title.
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Legal fees for obtaining a decrease in an assessment levied against property to pay for local improvements.
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Zoning costs.
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The capitalized value of a redeemable ground rent.
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.
Example.
Your city changes the street in front of your store into an enclosed pedestrian mall and assesses you and other affected landowners
for the cost of
the conversion. Add the assessment to your property's basis. In this example, the assessment is a depreciable asset.
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
that are
deductible as business expenses cannot be added to basis. However, you can choose either to deduct or to capitalize certain
other costs. If you
capitalize these costs, include them in your basis. If you deduct them, do not include them in your basis. (See Uniform Capitalization Rules,
earlier.)
The costs you can choose to deduct or to capitalize include the following.
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Carrying charges, such as interest and taxes, that you pay to own property, except carrying charges that must be capitalized
under the
uniform capitalization rules.
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Research and experimentation costs.
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Intangible drilling and development costs for oil, gas, and geothermal wells.
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Exploration costs for new mineral deposits.
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Mining development costs for a new mineral deposit.
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Costs of establishing, maintaining, or increasing the circulation of a newspaper or other periodical.
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Cost of removing architectural and transportation barriers to people with disabilities and the elderly. If you claim the disabled
access
credit, you must reduce the amount you deduct or capitalize by the amount of the credit.
For more information about deducting or capitalizing costs, see chapter 8 in Publication 535.
Table 1. Examples of Increases and Decreases 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
|
Exclusion from income of subsidies for energy conservation measures
Casualty or theft loss deductions and insurance reimbursements
Credit for qualified electric vehicles
|
Assessments for local improvements:
Water connections
Sidewalks
Roads
|
Section 179 deduction
Deduction for clean-fuel vehicles and clean-fuel vehicle refueling property
|
Casualty losses:
Restoring damaged property
|
Depreciation
Nontaxable corporate distributions
|
Legal fees:
Cost of defending and perfecting a title
|
|
| Zoning costs |
|
Table 1. Examples of Increases and Decreases 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
|
Exclusion from income of subsidies for energy conservation measures
Casualty or theft loss deductions and insurance reimbursements
Credit for qualified electric vehicles
|
Assessments for local improvements:
Water connections
Sidewalks
Roads
|
Section 179 deduction
Deduction for clean-fuel vehicles and clean-fuel vehicle refueling property
|
Casualty losses:
Restoring damaged property
|
Depreciation
Nontaxable corporate distributions
|
Legal fees:
Cost of defending and perfecting a title
|
|
| Zoning costs |
|
The following items reduce the basis of property.
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Section 179 deduction.
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Deduction for clean-fuel vehicles and refueling property.
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Nontaxable corporate distributions.
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Deductions previously allowed (or allowable) for amortization, depreciation, and depletion.
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Exclusion of subsidies for energy conservation measures.
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Credit for qualified electric vehicles.
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Postponed gain from sale of home.
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Investment credit (part or all) taken.
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Casualty and theft losses and insurance reimbursements.
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Certain canceled debt excluded from income.
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Rebates from a manufacturer or seller.
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Easements.
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Gas-guzzler tax.
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Tax credit or refund for buying a diesel-powered highway vehicle.
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Adoption tax benefits.
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Credit for employer-provided child care.
Some of these items are discussed next.
If you have a casualty or theft loss, decrease the basis in your property by any insurance 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 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. For more
information on casualty and theft losses, see Publication 547, Casualties, Disasters, and Thefts.
The amount you receive for granting an easement is generally considered to be a 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.
Credit for Qualified Electric Vehicles
If you claim the credit for a qualified electric vehicle, you must reduce your basis in that vehicle by the maximum credit
allowable even if the
credit allowed is less than that maximum amount. For information on this credit, see chapter 12 in Publication 535.
Decrease the basis in your car by the gas-guzzler (fuel economy) tax if you begin using the car within 1 year of the date
of its first sale for
ultimate use. This rule also applies to someone who later buys the car and begins using it not more than 1 year after the
original sale for ultimate
use. If the car is imported, the one-year period begins on the date of entry or withdrawal of the car from the warehouse if
that date is later
than the date of the first sale for ultimate use.
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 about the section 179 deduction, see Publication 946.
Deduction for Clean-Fuel Vehicles and 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 amount of the
deduction. For more information about these deductions, see chapter 12 in Publication 535.
Exclusion 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 any energy
conservation measure for a dwelling unit. Reduce the basis of the property for which you received the subsidy by the excluded
amount. For more
information on this subsidy, see Publication 525.
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 under the method chosen, decrease the basis by the amount you could
have taken under that
method. If you did not take a depreciation deduction, reduce the basis by the full amount of the depreciation you could have
taken.
Unless a timely election is made not to deduct the special depreciation allowance for property placed in service after September
10, 2001, decrease
the property's basis by the special depreciation allowance you deducted or could have deducted.
If you deducted more depreciation than you should have, decrease your basis by the amount equal to the depreciation you should
have deducted plus
the part of the excess depreciation you deducted that actually reduced your tax liability for the year.
In decreasing your basis for depreciation, take into account the amount deducted on your tax returns as depreciation and any
depreciation
capitalized under the uniform capitalization rules.
For information on figuring depreciation, see Publication 946.
If you are claiming depreciation on a business vehicle, see Publication 463. If the car is not used more than 50% for business
during the tax year,
you may have to recapture excess depreciation. Include the excess depreciation in your gross income and add it to your basis
in the property. For
information on the computation of excess depreciation, see chapter 4 in Publication 463.
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 canceled debt from income in the following situations.
-
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 from income canceled debt under situation (1) or (2), you may have to reduce the basis of your depreciable
and nondepreciable
property. However, in situation (3), you must reduce the basis of your depreciable property by the excluded amount.
For more information about canceled debt in a bankruptcy case or during insolvency, see Publication 908, Bankruptcy Tax Guide. For more
information about canceled debt that is qualified farm debt, see chapter 4 in Publication 225. For more information about
qualified real property
business debt, see chapter 5 in Publication 334, Tax Guide for Small Business.
Postponed Gain From Sale of Home
If you postponed gain from the sale of your main home before May 7, 1997, you must reduce the basis of your new home by the
postponed gain. For
more information on the rules for the sale of a home, see Publication 523.
If you claim an adoption credit for the cost of improvements you added to the basis of your home, decrease the basis of your
home by the credit
allowed. This also applies to amounts you received under an employer's adoption assistance program and excluded from income.
For more information on
these benefits, see Publication 968, Tax Benefits for Adoption.
Employer-Provided Child Care
If you are an employer, you can claim the employer-provided child care credit on amounts you paid or incurred to acquire,
construct, rehabilitate,
or expand property used as part of your qualified child care facility. You must reduce your basis in that property by the
credit claimed.
In January 1997, you paid $80,000 for real property to be used as a factory. You also paid commissions of $2,000 and title
search and legal fees of
$600. You allocated the total cost of $82,600 between the land and the building—$10,325 for the land and $72,275 for the building.
Immediately
you spent $20,000 in remodeling the building before you placed it in service. You were allowed depreciation of $14,526 for
the years 1997 through
2001. In 2000 you had a $5,000 casualty loss from a fire that was not covered by insurance on the building. You claimed a
deduction for this loss. You
spent $5,500 to repair the fire damages and extend the useful life of the building. The adjusted basis of the building on
January 1, 2002, is figured
as follows:
The basis of the land, $10,325, remains unchanged. It is not affected by any of the above adjustments.
There are many times when you cannot use cost as basis. In these cases, the fair market value or the adjusted basis of property
may be used.
Adjusted basis is discussed earlier.
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
FMV.
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.
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 forfeiture.
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.
Example.
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 do 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.
Example.
You received stock from your employer for services you performed. If you want to sell the stock while you are 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 must consider it when you figure the FMV.
Election.
You can 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 income.
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 property not similar or related in use to the
property exchanged.
Example.
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 can figure
the basis of the
replacement property you receive using the basis of the converted property.
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.
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Decrease the basis by the following.
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Any loss you recognize on the conversion.
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Any money you receive that you do not spend on similar property.
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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.
Example.
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:
Allocating the basis.
If you buy more than one piece of replacement property, allocate your basis among the properties based on their respective
costs.
Example.
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 respective
costs.
More information.
For more information about condemnations, see Involuntary Conversions in Publication 544. For more information about casualty and theft
losses, see Publication 547.
Terms you may need to know (see Glossary):
| Intangible 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.
Example.
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.
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 received.
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.
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 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 property dispositions.
-
Dispositions due to the death of either related person.
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Involuntary conversions.
-
Dispositions in which neither the original exchange nor the subsequent disposition had as a main purpose the avoidance of
federal income
tax.
Related persons.
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 of Publication 544.
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.
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