It is important to understand basis for tax purposes when you acquire property for a building project or to expand your facility. Basis is used to calculate depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange, or other disposition of the property. Knowing how basis is treated for tax purposes can save you a lot of money when it comes time to pay your taxes. Here are some of the basics:
Basis of Purchased Property – The IRS generally defines basis as the amount of your capital investment in property for tax purposes. In most situations, the basis of an asset is its cost to you. The cost is the amount you pay for the property in cash, debt obligations, and other property or services. Cost includes sales tax and other expenses connected with the purchase.
Basis of Inherited Property – According to Internal Revenue Code Section 1014, the tax basis of inherited property is generally the fair market value (FMV) on the date of death, or the alternate valuation date if that value was used on the decedent's estate tax return. Special rules apply if you inherit property in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin) or property held by a surviving tenant. There is also an exception for appreciated property.
If you do not have to file a federal estate tax return, the basis in the inherited property is its appraised value at the date of death for state inheritance or transmission taxes.
Basis of Gifts – The basis for gifted property is generally the lesser of the FMV of the property on the date of the gift or the giver’s basis. It is advisable to make a note of both basis values in case the property is sold for a profit or loss. Depending on the situation, the different bases may need to be considered to determine how the gain or loss is accounted for on a future tax return.
Basis in a Tax-Free §1031 Exchange – Generally, basis in a 1031 Exchange is the same as its basis in the property replaced in the transaction, plus additional costs incurred. If cash or other property is exchanged in the sale, those amounts are added to the property’s basis.
If unlike property (non-cash) was exchanged with the like-kind property, then a basis adjustment is applied first to the unlike property (up the FMV of the property) and then to the like-kind property. A gain or loss must be recognized on any unlike property, if applicable.
Basis for Property Received for Services – The basis for property received for services rendered is typically the FMV of the property on the date received. The basis must be included as income on the receiver’s tax return.
Adjustments to Basis – The costs of improvements or restorations are generally added to a property’s basis unless the expenses can be taken as a deduction. Reimbursements for improvements made, as well as tax credits, depreciation, and casualty losses (in the amount of the deductible loss and insurance or other reimbursements received) are subtracted. If a taxpayer is paid for an easement or other property rights, it is also subtracted from basis.
Safe harbors are available to rental property owners for certain costs to be expensed rather than capitalized if they are below specific thresholds.
Feel free to call us at 610.828.1900 if you have questions on basis. Contact either Michael Sexton, CPA, CCIFP, Director – Tax Services at Michael.Sexton@MCC-CPAs.com or me at Marty.McCarthy@MCC-CPAs.com. We are always happy to help.