For tax purposes, “basis” refers to the original value used to measure gains or losses. For instance, if you purchase shares of stock for $1,000, your basis is $1,000; if you sell those shares for $3,000, the gain is calculated by subtracting the basis from the sale price: $3,000 – $1,000 = $2,000. While this is a simplified example, it highlights the core concept of tax basis. In reality, costs like purchase and sale fees are added to the basis, but the principle remains the same. Basis is key when calculating deductions for depreciation, casualties, and depletion, as well as when determining gains or losses on the sale of an asset.
But here’s the kicker: basis isn’t always equal to the original purchase price. It can vary for purchases, gifts, and inheritances. Plus, it’s not static—basis can increase with improvements or decrease due to depreciation or casualty losses. This article will break down how basis is determined in different situations.
📌 Cost Basis – Cost basis, or unadjusted basis, is what you originally paid for an item before any improvements, depreciation, or adjustments due to losses.
📌 Adjusted Basis – Adjusted basis starts with the cost basis (or the value of a gift or inheritance) and includes:
- Increases for any improvements (repairs don’t count),
- Reductions for depreciation or expensing deductions, and
- Reductions for casualty-loss deductions.
Example: You bought a home for $250,000. Then you added a room for $50,000 and installed a solar system for $25,000, plus replaced the windows for $36,000. Your adjusted basis is now $361,000 ($250,000 + $50,000 + $25,000 + $36,000). Repairs and maintenance costs like repainting don’t count toward your basis.
Example: As the owner of a welding company, you buy a welder and generator for \$6,000. After using it for three years and deducting $3,376 in depreciation, you sell it. Your adjusted basis is now $2,624 ($6,000 – $3,376).
📌 Gift Basis – When you receive a gift, you take on the donor’s adjusted basis for tax purposes. Essentially, the donor transfers any potential taxable gain to you.
Example: Your mother gifts you stock worth $15,000. She originally purchased it for $5,000. Your basis is $5,000, and if you sell the shares right away, your gain is $10,000. However, if the gift’s fair market value (FMV) is lower than the donor’s basis and you sell at a loss, your loss will be based on the FMV.
Inherited Basis – When inheriting an asset, the tax basis is generally the FMV on the date of the original owner’s death. In most cases, this results in a “step-up” in basis, which reduces taxable gains for the beneficiary.
Example: You inherit a home with a FMV of $400,000, but your uncle’s original basis was $50,000. Your basis is now $400,000, which is the FMV at the time of inheritance.
The FMV of an inherited asset is crucial when determining gain or loss after a sale. If the estate executor cannot provide this information, it’s essential to get an appraisal. For real estate and businesses, professional appraisers are often required, while for vehicles and publicly traded stocks, online valuation tools can suffice.
This is just an overview of how basis affects your taxes. Got questions about your own situation? We’ve got answers. Contact our office today to get personalized help navigating your tax basis and making sure you’re making the right financial moves for 2024 and beyond.
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