Basis is a common IRS term, but probably does not enter into your everyday conversation. This IRS term is important because it impacts the taxes you pay when you sell, exchange or give away property.
What basis is
The IRS describes basis as:
The amount of your capital investment in a property for tax purposes. Use your basis to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange or other disposition of the property.
In plain language, basis is the cost of your property as defined by the tax code.
There are a few different types of basis that apply to different situations, including "cost basis," "adjusted basis," and "basis other than cost."
Types of basis
Cost basis. Your basis usually starts with what the item cost. Cost basis also includes sales tax paid, freight, installation, testing, legal fees and other fees to purchase the property. If you acquire a business you must often allocate the purchase price to each of the assets to establish their basis.
Tip: Retain records of any major transaction. Ensure the documentation includes all allowable costs that could be applied to your basis. This will help reduce taxes when you sell or dispose of the property.
Adjusted basis. When you sell, exchange or dispose of property you may have to adjust its basis to account for changes to the property since you acquired it. This is known as its adjusted basis. A common example of adjusted basis is when you add the costs of capital improvements to property that have a useful life for more than one year.
Adjusted basis can decrease the value of property as well. This is the case when property is affected by things such as casualty or theft losses, depreciation and other deductions.
Home tax tip: Adjusted basis applies to many home improvements. These could include a full roof replacement, adding a room to your home, or even special assessments for local improvements. Create a folder and retain all documentation that could add to your home’s basis. It may lower your capital gain when you sell your home.
Basis other than cost. What is the basis when you inherit property, receive property for services or receive property as a gift? In most cases, the basis is the fair market value of the item. This is the price a willing buyer would pay for the item and a willing seller would be willing to receive for that item. But there are also special basis rules for:
- Inherited property
- Like-kind exchange of property
- Involuntary conversions
- Property transferred to a spouse
Should any of these situations apply to you, please ask for a review of your circumstances, as establishing basis can become fairly complex.