Adjusted tax basis
Key takeaway
Adjusted tax basis is the starting basis of property increased or decreased by required adjustments. Basis measures your investment in property for tax purposes. It is used to figure depreciation, amortization, depletion, casualty losses, and gain or loss on a sale or other disposition.
How it works
Start with the acquisition
The starting basis of property you buy is usually its cost, including amounts paid in cash, debt obligations, other property or services. Purchased stocks and bonds generally include purchase costs such as commissions and recording or transfer fees. Cost is not the basis method for every acquisition, including gifts and inheritances.
Real estate basis includes settlement fees and closing costs that relate to buying the property. Fees and costs for obtaining a loan cannot be included in the property's basis.
Account for increases
Properly capitalized expenditures increase basis, including the cost of improvements with a useful life exceeding one year. Currently deductible expenses, including deductible incidental business repairs or maintenance, cannot also be added to basis. Where a choice between deduction and capitalization is available, capitalized costs enter basis and deducted costs do not.
Account for decreases
Depreciation reduces basis by the deductions taken or available under the depreciation method chosen, even if an available deduction was not claimed. Allowed or allowable amortization and depletion also reduce basis. If excessive depreciation was claimed, the reduction equals the correct depreciation plus the portion of the excess that actually reduced tax liability.
A casualty or theft loss reduces basis by insurance or other reimbursement and by any deductible loss not covered by insurance. Restoration spending increases basis when it substantially prolongs the property's life, increases its value or adapts it to a different use. Compare the repaired property with its condition before the casualty. Repair spending that does not otherwise improve the property does not increase basis.
Where basis matters for business and investment owners
Gifted stock
A lifetime gift generally carries over the donor's basis. If the donor's adjusted basis exceeds fair market value when the gift is made, that fair market value is used to determine a loss. The donor's basis applies to determining gain. A sale price between those two amounts produces neither gain nor loss.
The IRS illustrates gifted stock that the donor purchased for $10 per share, with that amount remaining the donor's basis. The recipient later sold the stock for $100 per share, producing a $90 per share gain subject to income tax. The IRS notes that property acquired from an estate follows different rules.
Gifted business property
For a gift held as business property, the basis for depreciation, depletion or amortization is the donor's adjusted basis plus or minus required adjustments while the recipient holds it. The limitation for determining a loss on disposition is separate. See Gifted stock.
Property converted to rental or business use
When property held for personal use becomes business or rental property, depreciation basis is the lesser of fair market value or adjusted basis on the conversion date. On a later sale, gain uses adjusted basis at sale. Loss starts with the lesser of fair market value or adjusted basis on the conversion date, then incorporates subsequent adjustments.
Points that are easy to confuse
On a sale or other disposition, gain generally equals the amount realized minus adjusted basis for gain. Loss generally equals adjusted basis for loss minus the amount realized. Computing gain or loss does not establish that the entire amount is currently recognized, because statutory exceptions can change recognition.
For inherited property subject to the statutory basis consistency cap, initial basis cannot exceed the final federal estate tax value. If no final value has been determined, the cap uses the value identified in a furnished basis reporting statement. The cap applies only when inclusion of the property increased federal estate tax liability after credits.
Common questions
What basis generally applies to property acquired from a decedent?
Property acquired from a decedent generally takes fair market value at death as its basis, subject to exceptions. A qualifying alternate valuation election substitutes the applicable alternate valuation value. Acquisition from the decedent includes bequests, inheritances, qualifying revocable trust property and property included in the gross estate.
The following answers explain the alternate valuation election and exceptions for returned gifts, income in respect of a decedent, special use valuation and conservation easements.
When can an executor elect alternate valuation?
An executor can elect alternate valuation only if it reduces both gross estate value and the combined estate and applicable generation skipping transfer taxes after credits. The executor makes the election on the estate tax return, and it covers all property included in the gross estate.
Property distributed, sold, exchanged or otherwise disposed of within six months after death is valued on disposition. Other property generally is valued six months after death. An interest affected by mere lapse of time uses its value at death, adjusted for changes unrelated to that lapse.
The election is irrevocable. It is unavailable if the return is filed more than one year after its prescribed due date, including extensions.
What basis applies when appreciated property returns to its donor after death?
Appreciated property given to a decedent within the one year period ending at death retains the decedent's adjusted basis immediately before death if it passes back to the donor or the donor's spouse. Appreciated means fair market value exceeded adjusted basis when the gift was made.
Does income in respect of a decedent receive a basis step up?
No. Income in respect of a decedent receives no basis step up. Such income was earned but not received by the decedent and was not properly includible on the decedent's final return. It is taxed in the year received to the estate or person acquiring the right to receive it.
How do special use valuation and conservation easements affect inherited basis?
Special use valuation chosen for estate tax purposes for qualifying farm or closely held business real property can set inherited basis. For land value excluded under the qualified conservation easement provision, the excluded portion retains the decedent's adjusted basis.
How does a nongrantor trust distribution affect basis?
A beneficiary receiving noncash property under section 643(e) generally takes the estate's or trust's adjusted basis immediately before distribution, adjusted for gain or loss the entity recognizes on that distribution.
Without an election, the amount carried out under these rules is the lesser of basis or fair market value. A section 643(e)(3) election instead causes the estate or trust to recognize gain or loss as if it sold the property to the beneficiary at fair market value. The election is made on that year's return and covers all noncash property distributions for the year. Revocation requires IRS consent.
Distributions described in section 663(a) are excluded from section 643(e). They include a gift or bequest of a specific sum of money or specific property under the governing instrument, properly paid or credited all at once or in no more than three installments. They also include amounts paid, permanently set aside or otherwise qualifying for the charitable deduction under section 642(c). An amount payable only from income is not a specific sum for this purpose.
Records that support adjusted basis
Accurate records must account for all items affecting basis so the relevant tax computations can be made. Required tax records must be retained while their contents may remain material to administering any internal revenue law, rather than for one universal fixed period.