Publication 17: Your Federal Income Tax; Basis of Property

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Table of Contents

Introduction

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

Cost basis.
Adjusted basis.
Basis other than cost.

Basis is the amount of your investment in property for tax purposes. Use the basis of property to figure gain or loss on the sale, exchange, or other disposition of property. Also use it to figure deductions for depreciation, amortization, depletion, and casualty losses. You must keep accurate records of all items that affect the basis of property so you can make these computations.

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.

Useful Items - You may want to see:

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.

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

Loans with low or no interest.

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

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

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 buildings and the land on which they stand for a lump sum, allocate the basis among the land and the buildings so you can figure the allowable depreciation on the buildings. Land is not depreciable. Allocate the cost according to the fair market values of the land and buildings at the time of purchase.

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

Assumption of mortgage.

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

Settlement costs.

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

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

Abstract fees (abstract of title fees).
Charges for installing utility services.
Legal fees (including 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 are some of the settlement fees and closing costs you cannot include in the basis of property.

Fire insurance premiums.
Rent for occupancy of the property before closing.
Charges for utilities or other services related to occupancy of the property before closing.
Charges connected with getting a loan. The following are examples of these charges.
1. Points (discount points, loan origination fees).
2. Mortgage insurance premiums.
3. Loan assumption fees.
4. Cost of a credit report.
5. Fees for an appraisal required by a lender.
Fees for refinancing a mortgage.

Real estate taxes.

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

Points.

If you pay points to get a loan (including a mortgage, second mortgage, line of credit, or a home equity loan), do not add the points to the basis of the related property. Generally, you deduct the points over the term of the loan. For more information on how to deduct points, see 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 any seller-paid points. For more information, see Points in chapter 25.

Before figuring gain or loss on a sale, exchange, or other disposition of property or figuring allowable depreciation, depletion, or amortization, you must usually make certain adjustments (increases and decreases) to the 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. Other items added to the basis of property include the cost of extending utility service lines to the property and legal fees, such as the cost of defending and perfecting title.

Improvements.

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

Assessments for local improvements.

Add assessments for improvements such as streets and sidewalks to the basis of the property if they increase the value of the property assessed. Do not deduct them as taxes. However, you can deduct as taxes assessments 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 property owners for the cost of the conversion. Add the assessment to your property's basis. In this example, the assessment is a depreciable asset.

The section 179 deduction.
The deduction for clean-fuel vehicles and clean-fuel vehicle refueling property.
Nontaxable corporate distributions (see chapter 9).
Deductions previously allowed (or allowable) for amortization, depreciation, and depletion.
Exclusion of subsidies for energy conservation measures (see Energy conservation subsidies in chapter 13).
Credit for qualified electric vehicles.
Postponed gain from the sale of your home.
Casualty and theft losses and insurance reimbursements.
Certain canceled debt excluded from income.
Rebates from a manufacturer or seller.
Easements.
Gas-guzzler tax.
Adoption tax benefits.
Credit for employer-provided childcare.

Table 14–1. Examples of Adjustments to Basis

Increases to Basis		Decreases to Basis
• Capital improvements:		• Exclusion from income of
	Putting an addition on your home	subsidies for energy conservation
	Replacing an entire roof	measures
	Paving your driveway
	Installing central air conditioning	• Casualty or theft loss deductions
	Rewiring your home	and insurance reimbursements

• Assessments for local improvements:		• Credit for qualified electric vehicles
	Water connections
	Sidewalks	• Section 179 deduction
	Roads
		• Deduction for clean-fuel vehicles
• Casualty losses:		and clean-fuel vehicle refueling property
	Restoring damaged property
		• Depreciation
• Legal fees:
	Cost of defending and perfecting a title	• Nontaxable corporate distributions

• Zoning costs

Casualties and thefts.

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

You must increase your basis in the property by the amount you spend on repairs that 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 chapter 27.

Depreciation and section 179 deduction.

Decrease the basis of your qualifying business property by any section 179 deduction you take and the depreciation you deducted, or could have deducted, on your tax returns under the method of depreciation you selected.

For more information about depreciation and the section 179 deduction, see Publication 946.

Example.

You owned a duplex used as rental property that cost you $40,000, of which $35,000 was allocated to the building and $5,000 to the land. You added an improvement to the duplex that cost $10,000. In February last year the duplex was damaged by fire. Up to that time you had been allowed depreciation of $23,000. You sold some salvaged material for $1,300 and collected $19,700 from your insurance company. You deducted a casualty loss of $1,000 on your income tax return for last year. You spent $19,000 of the insurance proceeds for restoration of the duplex, which was completed this year. You must use the duplex's adjusted basis after the restoration to determine depreciation for the rest of the property's recovery period. Figure the adjusted basis of the duplex as follows:

Original cost of duplex			$35,000
Addition to duplex			10,000
Total cost of duplex			$45,000
Minus:	Depreciation		23,000
Adjusted basis before casualty			$22,000
Minus:	Insurance proceeds	$19,700
	Deducted casualty loss	1,000
	Salvage proceeds	1,300	22,000
Adjusted basis after casualty			$–0–
Add: Cost of restoring duplex			19,000
Adjusted basis after restoration			$19,000

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

Easements.

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

If the gain is on a capital asset, see chapter 17 for information about how to report it. If the gain is on property used in a trade or business, see Publication 544 for information about how to report it.

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.

Deduction for clean-fuel vehicle 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 taken. 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 an 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 about this subsidy, see chapter 13.

Postponed gain from sale of home.

If you postponed gain from the sale of your main home under rules in effect before May 7, 1997, you must reduce the basis of the home you acquired as a replacement by the amount of the postponed gain. For more information on the rules for the sale of a home, see chapter 16.

There are many times when you cannot use cost as basis. In these cases, the fair market value or the adjusted basis of the property can be used. Fair market value (FMV) and adjusted basis were discussed earlier.

If you receive property for your services, include its 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.

Restricted property.

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. However, this rule does not apply if you make an election to include in income the FMV of the property at the time it is transferred to you, less any amount you paid for it. 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. For more information, see Restricted Property in Publication 525.

Bargain purchases.

A bargain purchase is a purchase of an item for less than its FMV. If, as compensation for services, you buy 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 is 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.

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. 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.

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 using the basis of the converted property.

Similar or related property.

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

Decrease the basis by the following.
1. Any loss you recognize on the conversion.
2. Any money you receive that you do not spend on similar property.
Increase the basis by the following.
1. Any gain you recognize on the 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 conversion.

Example.

The state condemned your property. The adjusted basis of the property was $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 unrecognized gain is $3,000, the difference between the $5,000 realized gain and the $2,000 recognized gain. The basis of the replacement property is figured as follows:

Cost of replacement property	$29,000
Minus: Gain not recognized	3,000
Basis of replacement property	$26,000

Allocating the basis.

If you buy more than one piece of replacement property, allocate your basis among the properties based on their respective costs.

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 generally the same as the basis of the property you transferred. See Nontaxable Trades in chapter 15.

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, the property traded and the property received must be both of the following.

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

Qualifying property.

In a like-kind exchange, you must hold for investment or for productive use in your trade or business both the property you give up and the property you receive.

Like-kind property.

There must be an exchange of like property. Like-kind property is property of the same nature or character, even if it differs in grade or quality. The exchange of real estate for real estate or personal property for similar personal property is an exchange of like property.

Example.

You trade in an old truck used in your business with an adjusted basis of $1,700 for a new one costing $6,800. The dealer allows you $2,000 on the old truck, and you pay $4,800. This is a like-kind exchange. The basis of the new truck is $6,500 (the adjusted basis of the old one, $1,700, plus the amount you paid, $4,800).

If you sell your old truck to a third party for $2,000 instead of trading it in and then buy a new one from the dealer, you have a taxable gain of $300 on the sale ($2,000 sale price minus $1,700 basis). The basis of the new truck is the price you pay the dealer.

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 total adjusted basis of the property you gave up, with the following adjustments.

Decrease the basis by the following amounts.
1. Any money you receive.
2. Any loss you recognize on the exchange.
Increase the basis by the following amounts.
1. Any additional costs you incur.
2. Any gain you recognize on the exchange.

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-kind property.

More information.

See Like-Kind Exchanges in chapter 1 of Publication 544 for more information.

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 that 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.

If the property transferred to you is a series E, series EE, or series I U.S. 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 includible in the transferor's income. For more information on these bonds, see chapter 8.

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

For more information about the transfer of property from a spouse, see chapter 15.

To figure the basis of property you receive as a gift, you must know its adjusted basis 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 adjustments 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 adjustments to basis while you held the property. See Adjusted Basis, earlier.

Example.

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 property, no events occurred to increase or decrease your basis. If you later sell the property for $12,000, you will have a $2,000 gain because you must use the donor's adjusted basis at the time of the gift ($10,000) as your basis to figure gain. If you sell the property for $7,000, you will have a $1,000 loss because you must use the FMV at the time of the gift ($8,000) as your basis to figure loss.

If the sales price is between $8,000 and $10,000, you have neither gain nor loss.

Business property.

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 greater 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, explained later.

Also, for figuring gain or loss from a sale or other disposition or for figuring depreciation, depletion, or amortization deductions on business property, you must increase or decrease your 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 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.

Gift received after 1976.

If you received a gift after 1976, increase your basis in the gift 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 a fraction. The numerator of the fraction 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 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 on the property. Your basis is $26,930, 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

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 death.
The FMV on the alternate valuation date if the personal representative for the estate chooses to use alternate valuation.
The value under the special-use valuation method for real property used in farming or a closely held business if chosen for estate tax purposes.
The decedent's adjusted basis in land to the extent of the value excluded from the decedent's taxable estate as a qualified conservation easement.

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.

For more information, see the instructions to Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return.

If you hold property for personal use and then 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 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.

Example.

Several years ago, you paid $160,000 to have your house built on a lot that cost $25,000. You paid $20,000 for permanent improvements to the house and claimed a $2,000 casualty loss deduction for damage to the house before changing the property to rental use last year. Because land is not depreciable, you include only 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 had an FMV of $180,000, of which $15,000 was for the land and $165,000 was for the house. The basis for figuring depreciation on the house is its FMV on the date of the change ($165,000) because it is less than your adjusted basis ($178,000).

Sale of property.

If you later sell or dispose of property changed to business or rental use, the basis you use will depend on whether you are figuring gain or loss.

Gain.

The basis for figuring a gain is your adjusted basis in the property when you sell.

Example.

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).

Loss.

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.

Example.

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).

The basis of stocks or bonds you buy generally is 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 FMV or the previous owner's adjusted basis, as discussed earlier.

You must adjust the basis of stocks for certain events that occur after purchase. For example, if you receive additional stock from nontaxable stock dividends or stock splits, divide the adjusted basis of the old stock by the number of shares of old and new stock. This rule applies only when the additional stock received is identical to the stock held. Also reduce your basis when you receive nontaxable distributions. They are a return of capital.

Other basis.

There are other ways to figure the basis of stocks or bonds depending on how you acquired them. For detailed information, see Stocks and Bonds under Basis of Investment Property in chapter 4 of Publication 550.

Identifying stocks 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 stocks 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 you acquired at various times and prices, you can choose to use an average basis. For more information, see Average Basis in Publication 564.

Bond premium.

If you buy a taxable bond at a premium and choose to amortize the premium, reduce the basis of the bond by the amortized premium you deduct each year. See Bond Premium Amortization in chapter 3 of Publication 550 for more information. Although you cannot deduct the premium on a tax-exempt bond, you must amortize the premium each year and reduce your basis in the bond by the amortized amount.