Publication 551 Contents (Rev. May 2002)

Cat. No. 15094C Important Reminder ...............

1 Department

of the Introduction .....................

1 Treasury Basis of Internal Cost Basis ...................... 2

Revenue Stocks and Bonds ..............

2

Service Assets Real Property .................

2

Business Assets ...............3

Allocating the Basis .............4

Adjusted Basis ..................4

Increases to Basis ..............4

Decreases to Basis .............5

Basis Other Than Cost .............6

Property Received for Services ......6

Taxable Exchanges .............7

Nontaxable Exchanges ...........7

Like-Kind Exchanges ............7

Property Transferred From a

Spouse ...................8

Property Received as a Gift ........8

Inherited Property ..............9

Property Changed to Business or

Rental Use ................ 10

How To Get Tax Help .............. 10

Glossary ....................... 11

Index .......................... 12

Important Reminder

Assets held on January 1, 2001. If you made

the election to treat an asset as sold and then

reacquired on January 1, 2001 (January 2,

2001, for readily tradable stock), and you hold

the asset for more than 5 years from that date,

any future gain on the asset is eligible for an

18% (instead of 20%) capital gains tax rate. If

you made the election, your basis in the reacquired asset is its closing market price (for readily tradable stock) or fair market value (for any

other capital asset or property used in a trade or

business) on the date you reacquired it.

Introduction

Basis is the amount of your investment in property for tax purposes. Use the basis of property

to figure depreciation, amortization, depletion,

and casualty losses. Also use it to figure gain or

loss on the sale or other disposition of property.

You must keep accurate records of all items that

affect the basis of property so you can make

these computations.

This publication is divided into the following

sections. • Cost Basis • Adjusted Basis • Basis Other Than Cost

The basis of property you buy is usually its

cost. You may also have to capitalize (add to
basis) certain other costs related to buying or you acquired first. For more information about

producing the property. Cost Basis identifying securities you sell, see Stocks and

Bonds under Basis of Investment Property in Your original basis in property is adjusted Terms you may need to know chapter 4 of Publication 550. (increased or decreased) by certain events. If (see Glossary): you make improvements to the property, in- Mutual fund shares. If you sell mutual fund crease your basis. If you take deductions for shares acquired at different times and prices, depreciation or casualty losses, reduce your ba- Business assets you can choose to use an average basis. For sis. Real property more information, see Average Basis in PublicaYou cannot determine your basis in some tion 564. Unstated interest

assets by cost. This includes property you receive as a gift or inheritance. It also applies to Real Property

property received in an involuntary conversion The basis of property you buy is usually its cost. If you buy real property, certain fees and other and certain other circumstances. The cost is the amount you pay in cash, debt expenses become part of your cost basis in the obligations, other property, or services. Your property. cost also includes amounts you pay for the fol- Comments and suggestions. We welcome lowing items. your comments about this publication and your Real estate taxes. If you pay real estate taxes • Sales tax. suggestions for future editions. the seller owed on real property you bought, and

• Freight. the seller did not reimburse you, treat those You can e-mail us while visiting our web site taxes as part of your basis. You cannot deduct at www.irs.gov. • Installation and testing. them as taxes.

You can write to us at the following address: • Excise taxes. If you reimburse the seller for taxes the seller

paid for you, you can usually deduct that amount • Legal and accounting fees (when they Internal Revenue Service as an expense in the year of purchase. Do not must be capitalized). Technical Publications Branch include that amount in the basis of the property.

W:CAR:MP:FP:P • Revenue stamps. If you did not reimburse the seller, you must

reduce your basis by the amount of those taxes. 1111 Constitution Ave. NW • Recording fees.

Washington, DC 20224 • Real estate taxes (if assumed for the Settlement costs. You can include in the baseller). sis of property you buy the settlement fees and

We respond to many letters by telephone. closing costs for buying the property. You cannot include fees and costs for getting a loan on Therefore, it would be helpful if you would in- You may also have to capitalize certain other the property. (A fee for buying property is a cost clude your daytime phone number, including the costs related to buying or producing property. that must be paid even if you bought the prop- area code, in your correspondence. erty for cash.) Loans with low or no interest. If you buy The following items are some of the settle- Useful Items property on a time-payment plan that charges ment fees or closing costs you can include in the little or no interest, the basis of your property is You may want to see: basis of your property. your stated purchase price, minus the amount

considered to be unstated interest. You gener- • Abstract fees (abstract of title fees). Publication ally have unstated interest if your interest rate is • Charges for installing utility services. ❏ 463 Travel, Entertainment, Gift, and Car less than the applicable federal rate. See the

Expenses discussion of unstated interest in Publication • Legal fees (including title search and prep- 537. aration of the sales contract and deed). ❏ 523 Selling Your Home

Purchase of a business. When you purchase • Recording fees. ❏ 525 Taxable and Nontaxable Income a trade or business, you generally purchase all • Surveys. ❏ 527 Residential Rental Property assets used in the business operations, such as

land, buildings, and machinery. Allocate the • Transfer taxes. ❏ 530 Tax Information for First-Time price among the various assets including any Homeowners • Owner’s title insurance. section 197 intangibles. See Allocating the Ba-

❏ 535 Business Expenses sis, later. • Any amounts the seller owes that you

agree to pay, such as back taxes or inter- ❏ 537 Installment Sales Stocks and Bonds est, recording or mortgage fees, charges

❏ 544 Sales and Other Dispositions of for improvements or repairs, and sales

Assets The basis of stocks or bonds you buy is gener- commissions.

ally the purchase price plus any costs of ❏ 550 Investment Income and Expenses purchase, such as commissions and recording Settlement costs do not include amounts

❏ 559 Survivors, Executors, and or transfer fees. If you get stocks or bonds other placed in escrow for the future payment of items

Administrators than by purchase, your basis is usually deter- such as taxes and insurance.

mined by the fair market value (FMV) or the The following items are some settlement ❏ 564 Mutual Fund Distributions previous owner’s adjusted the basis of stock. fees and closing costs you cannot include in the

You must adjust the basis of stocks for cer- ❏ 587 Business Use of Your Home basis of the property. tain events that occur after purchase. See

❏ 946 How To Depreciate Property Stocks and Bonds in chapter 4 of Publication 1) Fire insurance premiums.

550 for more information on the basis of stock.

Form (and Instructions) 2) Rent for occupancy of the property before

Identifying stock or bonds sold. If you can closing. ❏ 706-A United States Additional Estate adequately identify the shares of stock or the 3) Charges for utilities or other services re- Tax Return bonds you sold, their basis is the cost or other lated to occupancy of the property before

❏ basis of the particular shares of stock or bonds. 8594 Asset Acquisition Statement closing. If you buy and sell securities at various times in See How To Get Tax Help near the end of varying quantities and you cannot adequately 4) Charges connected with getting a loan.

this publication for information about getting identify the shares you sell, the basis of the The following are examples of these

publications and forms. securities you sell is the basis of the securities charges.

Page 2
a) Points (discount points, loan origination Do not deduct these expenses. You must capi- Under the uniform capitalization rules, you

fees). talize them (include them in the asset’s basis). must capitalize all direct costs and an allocable

Also, reduce your basis by any work opportunity part of most indirect costs you incur due to your b) Mortgage insurance premiums. credit, welfare-to-work credit, Indian employ- production or resale activities. The term capitalc) Loan assumption fees. ment credit, or empowerment zone employment ize means to include certain expenses in the

credit allowable on the wages you pay in (1), basis of property you produce or in your inven- d) Cost of a credit report. above. For information about these credits, see tory costs rather than deduct them as a current

e) Fees for an appraisal required by a Publication 954, Tax Incentives for Empower- expense. You recover these costs through delender. ment Zones and Other Distressed Communi- ductions for depreciation, amortization, or cost

ties. of goods sold when you use, sell, or otherwise

5) Fees for refinancing a mortgage. dispose of the property.

Do not include the value of your own Any cost you cannot use to figure your taxa- If these costs relate to business property, items labor, or any other labor you did not ble income for any tax year is not subject to the (1) through (3) are deductible as business ex- pay for, in the basis of any property you uniform capitalization rules. CAUTION

!

penses. Items (4) and (5) must be capitalized construct. as costs of getting a loan and can be deducted Example. If you incur a business meal ex- over the period of the loan. pense for which your deduction would be limited Business Assets to 50% of the cost of the meal, that amount is Points. If you pay points to obtain a loan (in- subject to the uniform capitalization rules. The cluding a mortgage, second mortgage, line of Terms you may need to know nondeductible part of the cost is not subject to credit, or a home equity loan), do not add the (see Glossary): the uniform capitalization rules. points to the basis of the related property. Generally, you deduct the points over the term of the More information. For more information Amortization loan. For more information on how to deduct about these rules, see the regulations under

points, see Points in chapter 5 of Publication Capitalization section 263A of the Internal Revenue Code and

535. Publication 538, Accounting Periods and Meth- Depletion ods. Points on home mortgage. Special rules Depreciation may apply to points you and the seller pay when Exceptions. The following are not subject to you obtain a mortgage to purchase your main Fair market value the uniform capitalization rules. home. If certain requirements are met, you can Going concern value deduct the points in full for the year in which they 1) Property you produce that you do not use

are paid. Reduce the basis of your home by any Goodwill in your trade, business, or activity conseller-paid points. For more information, see ducted for profit. Intangible property Points in Publication 936, Home Mortgage Inter- 2) Qualified creative expenses you pay or in- est Deduction. Personal property cur as a free-lance (self-employed) writer,

Assumption of mortgage. Recapture photographer, or artist that are otherwise If you buy prop- deductible on your tax return. erty and assume (or buy subject to) an existing Section 179 deduction

mortgage on the property, your basis includes 3) Property you produce under a long-term Section 197 intangibles the amount you pay for the property plus the contract, except for certain home construc- amount to be paid on the mortgage. Tangible property tion contracts.

Example. 4) Research and experimental expenses al- If you buy a building for $20,000

cash and assume a mortgage of $80,000 on it, If you purchase property to use in your business, lowable as a deduction under section 174

your basis is $100,000. of the Internal Revenue Code. your basis is usually its actual cost to you. If you

construct, create, or otherwise produce prop- 5) Costs for personal property acquired for Constructing assets. If you build property or erty, you must capitalize the costs as your basis. resale if your (or your predecessor’s) aver- have assets built for you, your expenses for this In certain circumstances, you may be subject to age annual gross receipts for the 3 previ- construction are part of your basis. Some of the uniform capitalization rules, next. ous tax years do not exceed $10 million. these expenses include the following items.

For other exceptions to the uniform capitaliza- • Cost of the land. Uniform Capitalization Rules tion rules, see section 1.263A-1(b) of the regula-

• Cost of labor and materials. tions.

The uniform capitalization rules specify the For information on the special rules that ap- • Architect’s fees. costs you add to basis in certain circumstances. ply to costs incurred in the business of farming,

• Building permit charges. see chapter 7 of Publication 225, Farmer’s Tax

Activities subject to the rules. You must use Guide. • Payments to contractors. the uniform capitalization rules if you do any of

the following in your trade or business or activity • Payments for rental equipment. carried on for profit. Intangible Assets • Inspection fees. • Produce real or tangible personal property Intangible assets include goodwill, patents, In addition, if you own a business and use your for use in the business or activity. copyrights, trademarks, trade names, and employees, material, and equipment to build an franchises. The basis of an intangible asset is asset, your basis would also include the follow- • Produce real or tangible personal property usually the cost to buy or create it. If you acquire for sale to customers. ing costs. multiple assets, for example a going business • Acquire property for resale. 1) Employee wages paid for the construction for a lump sum, see Allocating the Basis, later, to

work. figure the basis of the individual assets. The You produce property if you construct, build, basis of certain intangibles can be amortized. 2) Depreciation on equipment you own while install, manufacture, develop, improve, create, See chapter 9 of Publication 535 for information it is used in the construction. raise, or grow the property. Treat property pro- on the amortization of these costs.

duced for you under a contract as produced by 3) Operating and maintenance costs for you up to the amount you pay or costs you Patents. The basis of a patent you get for an equipment used in the construction. otherwise incur for the property. Tangible per- invention is the cost of development, such as

4) The cost of business supplies and materi- sonal property includes films, sound recordings, research and experimental expenditures, drawals used in the construction. video tapes, books, or similar property. ings, working models, and attorneys’ and govPage 3
ernmental fees. If you deduct the research and Agreement. The buyer and seller may enter cost for common improvements. See Revenue

experimental expenditures as current business into a written agreement as to the allocation of Procedure 92–29 for more information, includexpenses, you cannot include them in the basis any consideration or the fair market value (FMV) ing an explanation of the procedures for getting

of the patent. The value of the inventor’s time of any of the assets. This agreement is binding consent from the IRS.

spent on an invention is not part of the basis. on both parties unless the IRS determines the Use of erroneous cost basis. If you made amounts are not appropriate. Copyrights. If you are an author, the basis of a mistake in figuring the cost basis of subdivided

a copyright will usually be the cost of getting the Reporting requirement. Both the buyer and lots sold in previous years, you cannot correct

copyright plus copyright fees, attorneys seller involved in the sale of business assets the mistake for years for which the statute of ’ fees,

clerical assistance, and the cost of plates that must report to the IRS the allocation of the sales limitations (generally 3 tax years) has expired.

price among section 197 intangibles and the Figure the basis of any remaining lots by allocat- remain in your possession. Do not include the

value of your time as the author, or any other other business assets. Use Form 8594 to pro- ing the correct original cost basis of the entire

person vide this information. The buyer and seller tract among the original lots. ’s time you did not pay for.

should each attach Form 8594 to their federal

Franchises, trademarks, and trade names. income tax return for the year in which the sale Example. You bought a tract of land to

If you buy a franchise, trademark, or trade name, occurred. which you assigned a cost of $15,000. You subthe basis is its cost, unless you can deduct your divided the land into 15 building lots of equal

payments as a business expense. More information. See Sale of a Business in size and equitably divided your basis so that chapter 2 of Publication 544 for more informa- each lot had a basis of $1,000. You treated the

tion. Allocating the Basis sale of each lot as a separate transaction and

figured gain or loss separately on each sale.

If you buy multiple assets for a lump sum, allo- Several years later you determine that your

cate the amount you pay among the assets you Land and Buildings original basis in the tract was $22,500 and not

receive. You must make this allocation to figure $15,000. You sold eight lots using $8,000 of If you buy buildings and the land on which they your basis for depreciation and gain or loss on a basis in years for which the statute of limitations stand for a lump sum, allocate the basis of the later disposition of any of these assets. See has expired. You now can take $1,500 of basis property among the land and the buildings so Trade or Business Acquired, later. into account for figuring gain or loss only on the you can figure the depreciation allowable on the sale of each of the remaining seven lots buildings. ($22,500 basis divided among all 15 lots). You Figure the basis of each asset by multiplying Group of Assets Acquired cannot refigure the basis of the eight lots sold in the lump sum by a fraction. The numerator is the tax years barred by the statute of limitations. If you buy multiple assets for a lump sum, you FMV of that asset and the denominator is the

and the seller may agree to a specific allocation FMV of the whole property at the time of

of the purchase price among the assets in the purchase. If you are not certain of the FMV of the

land and buildings, you can allocate the basis sales contract. If this allocation is based on the

value of each asset and you and the seller have based on their assessed values for real estate Adjusted Basis

adverse tax interests, the allocation generally tax purposes.

Before figuring gain or loss on a sale, exchange, will be accepted. However, see Trade or Busi- Demolition of building. Add demolition costs or other disposition of property or figuring allow- ness Acquired, next. and other losses incurred for the demolition of able depreciation, depletion, or amortization, any building to the basis of the land on which the you must usually make certain adjustments to demolished building was located. Do not claim the basis of the property. The result of these Trade or Business Acquired the costs as a current deduction. adjustments to the basis is the adjusted basis.

If you acquire a trade or business, allocate the Modification of building. A modification of

consideration paid to the various assets ac- a building will not be treated as a demolition if Increases to Basis

quired. Generally, reduce the consideration paid the following conditions are satisfied.

by any cash and general deposit accounts (in- Increase the basis of any property by all items • 75 percent or more of the existing external cluding checking and savings accounts) re- properly added to a capital account. These in- walls of the building are retained in place ceived. Allocate the remaining consideration to clude the cost of any improvements having a as internal or external walls. the other business assets received in proportion useful life of more than 1 year.

to (but not more than) their fair market value in • 75 percent or more of the existing internal Rehabilitation expenses also increase basis.

the following order. structural framework of the building is re- However, you must subtract any rehabilitation

tained in place. credit allowed for these expenses before you 1) Certificates of deposit, U.S. Government add them to your basis. If you have to recapture securities, foreign currency, and actively If the building is a certified historic structure, any of the credit, increase your basis by the traded personal property, including stock the modification must also be part of a certified recaptured amount. and securities. rehabilitation. If you make additions or improvements to

2) Accounts receivable, other debt instru- If these conditions are met, add the costs of business property, keep separate accounts for

ments, and assets you mark to market at the modifications to the basis of the building. them. Also, you must depreciate the basis of

each according to the depreciation rules that least annually for federal income tax pur- Subdivided lots. If you buy a tract of land and poses. would apply to the underlying property if you had subdivide it, you must determine the basis of placed it in service at the same time you placed 3) Property of a kind that would properly be each lot. This is necessary because you must the addition or improvement in service. For more included in inventory if on hand at the end figure the gain or loss on the sale of each individ- information, see Publication 946. of the tax year or property held primarily ual lot. As a result, you do not recover your The following items increase the basis of for sale to customers in the ordinary entire cost in the tract until you have sold all of property. course of business. the lots.

To determine the basis of an individual lot, • The cost of extending utility service lines 4) All other assets except section 197 in- multiply the total cost of the tract by a fraction. to the property. tangibles, goodwill, and going concern The numerator is the FMV of the lot and the value. • Impact fees. denominator is the FMV of the entire tract.

5) Section 197 intangibles except goodwill • Legal fees, such as the cost of defending Future improvement costs. If you are a and going concern value. and perfecting title. developer and sell subdivided lots before the

6) Goodwill and going concern value development work is completed, you can (with • Legal fees for obtaining a decrease in an

(whether or not they qualify as section 197 IRS consent) include in the basis of the proper- assessment levied against property to pay

intangibles). ties sold an allocation of the estimated future for local improvements.

Page 4
Table 1. Examples of Increases and Decreases to Basis Casualties and Thefts

If you have a casualty or theft loss, decrease the Increases to Basis Decreases to Basis

basis in your property by any insurance or other Capital improvements: Exclusion from income of subsidies for energy reimbursement and by any deductible loss not Putting an addition on your home conservation measures covered by insurance. Replacing an entire roof

 Paving your driveway Casualty or theft loss deductions and insurance You must increase your basis in the property

 Installing central air conditioning reimbursements by the amount you spend on repairs that sub- Rewiring your home stantially prolong the life of the property, in- Credit for qualified electric vehicles crease its value, or adapt it to a different use. To

Assessments for local improvements: Section 179 deduction make this determination, compare the repaired Water connections property to the property before the casualty. For Sidewalks Deduction for clean-fuel vehicles and clean-fuel more information on casualty and theft losses, Roads vehicle refueling property see Publication 547, Casualties, Disasters, and Casualty losses: Depreciation Thefts. Restoring damaged property

Nontaxable corporate distributions

Legal fees: Easements

 Cost of defending and perfecting a title

The amount you receive for granting an ease- Zoning costs ment is generally considered to be a sale of an

interest in real property. It reduces the basis of

• Zoning costs. • Costs of establishing, maintaining, or in- the affected part of the property. If the amount

creasing the circulation of a newspaper or received is more than the basis of the part of the • The capitalized value of a redeemable other periodical. property affected by the easement, reduce your ground rent. basis in that part to zero and treat the excess as • Cost of removing architectural and trans- a recognized gain. portation barriers to people with disabilities Assessments for and the elderly. If you claim the disabled Local Improvements access credit, you must reduce the Credit for Qualified Electric amount you deduct or capitalize by the Increase the basis of property by assessments amount of the credit. Vehicles for items such as paving roads and building

ditches that increase the value of the property If you claim the credit for a qualified electric For more information about deducting or capi- assessed. Do not deduct them as taxes. How- vehicle, you must reduce your basis in that vehi- talizing costs, see chapter 8 in Publication 535. ever, you can deduct as taxes charges for main- cle by the maximum credit allowable even if the tenance, repairs, or interest charges related to Decreases to Basis credit allowed is less than that maximum the improvements. amount. For information on this credit, see chapExample. Your city changes the street in The following items reduce the basis of property. ter 12 in Publication 535.

front of your store into an enclosed pedestrian • Section 179 deduction.

mall and assesses you and other affected landowners for the cost of the conversion. Add the • Deduction for clean-fuel vehicles and re- Gas-Guzzler Tax

fueling property. assessment to your property’s basis. In this ex- Decrease the basis in your car by the gas-guz- ample, the assessment is a depreciable asset. • Nontaxable corporate distributions. zler (fuel economy) tax if you begin using the car

• Deductions previously allowed (or allowa- within 1 year of the date of its first sale for

Deducting vs. Capitalizing Costs ble) for amortization, depreciation, and de- ultimate use. This rule also applies to someone

pletion. who later buys the car and begins using it not

Do not add to your basis costs you can deduct more than 1 year after the original sale for ulti- • Exclusion of subsidies for energy conser- as current expenses. For example, amounts vation measures. mate use. If the car is imported, the one-year paid for incidental repairs or maintenance that period begins on the date of entry or withdrawal are deductible as business expenses cannot be • Credit for qualified electric vehicles. of the car from the warehouse if that date is later added to basis. However, you can choose either • Postponed gain from sale of home. than the date of the first sale for ultimate use. to deduct or to capitalize certain other costs. If

you capitalize these costs, include them in your • Investment credit (part or all) taken.

basis. If you deduct them, do not include them in • Casualty and theft losses and insurance Section 179 Deduction your basis. (See Uniform Capitalization Rules, reimbursements. earlier.) If you take the section 179 deduction for all or • Certain canceled debt excluded from in- The costs you can choose to deduct or to part of the cost of qualifying business property, come. capitalize include the following. decrease the basis of the property by the deduc-

• Rebates from a manufacturer or seller. tion. For more information about the section 179 • Carrying charges, such as interest and deduction, see Publication 946. taxes, that you pay to own property, ex- • Easements.

cept carrying charges that must be capital- • Gas-guzzler tax. ized under the uniform capitalization rules. Deduction for Clean-Fuel Vehicles • Tax credit or refund for buying a • Research and experimentation costs. diesel-powered highway vehicle. and Refueling Property

• Intangible drilling and development costs • Adoption tax benefits. If you take the deduction for clean-fuel vehicles for oil, gas, and geothermal wells. or clean-fuel vehicle refueling property, de- • Credit for employer-provided child care. • Exploration costs for new mineral depos- crease the basis of the property by the amount

its. Some of these items are discussed next. of the deduction. For more information about

• Mining development costs for a new min- these deductions, see chapter 12 in Publication

eral deposit. 535.

Page 5
Exclusion of Subsidies for Energy property. However, in situation (3), you must The basis of the land, $10,325, remains unConservation Measures reduce the basis of your depreciable property by changed. It is not affected by any of the above

the excluded amount. adjustments.

You can exclude from gross income any subsidy For more information about canceled debt in

you received from a public utility company for a bankruptcy case or during insolvency, see the purchase or installation of any energy con- Publication 908, Bankruptcy Tax Guide. For servation measure for a dwelling unit. Reduce more information about canceled debt that is Basis Other Than Cost the basis of the property for which you received qualified farm debt, see chapter 4 in Publication the subsidy by the excluded amount. For more 225. For more information about qualified real There are many times when you cannot use cost information on this subsidy, see Publication 525. property business debt, see chapter 5 in Publi- as basis. In these cases, the fair market value or

cation 334, Tax Guide for Small Business. the adjusted basis of property may be used.

Adjusted basis is discussed earlier. Depreciation

Postponed Gain From Sale of Fair market value (FMV). FMV is the price at Decrease the basis of property by the deprecia- Home which property would change hands between a tion you deducted, or could have deducted, on buyer and a seller, neither having to buy or sell, your tax returns under the method of deprecia- If you postponed gain from the sale of your main and both having reasonable knowledge of all tion you chose. If you took less depreciation than home before May 7, 1997, you must reduce the necessary facts. Sales of similar property on or you could have under the method chosen, de- basis of your new home by the postponed gain. about the same date may be helpful in figuring crease the basis by the amount you could have For more information on the rules for the sale of the property’s FMV. taken under that method. If you did not take a a home, see Publication 523. depreciation deduction, reduce the basis by the

full amount of the depreciation you could have Property Received

taken. for Services Adoption Tax Benefits Unless a timely election is made not to deduct the special depreciation allowance for prop- If you receive property for services, include the If you claim an adoption credit for the cost of erty placed in service after September 10, 2001, property’s FMV in income. The amount you in- improvements you added to the basis of your decrease the property clude in income becomes your basis. If the ser- ’s basis by the special home, decrease the basis of your home by the depreciation allowance you deducted or could vices were performed for a price agreed on credit allowed. This also applies to amounts you have deducted. beforehand, it will be accepted as the FMV of the received under an employer’s adoption assis- property if there is no evidence to the contrary. If you deducted more depreciation than you tance program and excluded from income. For should have, decrease your basis by the amount more information on these benefits, see Publica- equal to the depreciation you should have de- tion 968, Tax Benefits for Adoption. Bargain Purchases ducted plus the part of the excess depreciation

you deducted that actually reduced your tax A bargain purchase is a purchase of an item for liability for the year. Employer-Provided Child Care less than its FMV. If, as compensation for ser- In decreasing your basis for depreciation, vices, you purchase goods or other property at take into account the amount deducted on your If you are an employer, you can claim the less than FMV, include the difference between tax returns as depreciation and any depreciation employer-provided child care credit on amounts the purchase price and the property’s FMV in

capitalized under the uniform capitalization you paid or incurred to acquire, construct, reha- your income. Your basis in the property is its rules. bilitate, or expand property used as part of your FMV (your purchase price plus the amount you For information on figuring depreciation, see qualified child care facility. You must reduce include in income). Publication 946. your basis in that property by the credit claimed. If the difference between your purchase If you are claiming depreciation on a busi- price and the FMV represents a qualified em- ness vehicle, see Publication 463. If the car is Example ployee discount, do not include the difference in not used more than 50% for business during the income. However, your basis in the property is tax year, you may have to recapture excess In January 1997, you paid $80,000 for real prop- still its FMV. See Employee Discounts in Publidepreciation. Include the excess depreciation in erty to be used as a factory. You also paid cation 15–B, Employer’s Tax Guide to Fringe your gross income and add it to your basis in the commissions of $2,000 and title search and le- Benefits. property. For information on the computation of gal fees of $600. You allocated the total cost of

excess depreciation, see chapter 4 in Publica- $82,600 between the land and the building—

tion 463. $10,325 for the land and $72,275 for the build- Restricted Property ing. Immediately you spent $20,000 in remodeling the building before you placed it in service. If you receive property for your services and the

Canceled Debt Excluded You were allowed depreciation of $14,526 for property is subject to certain restrictions, your

From Income the years 1997 through 2001. In 2000 you had a basis in the property is its FMV when it becomes

$5,000 casualty loss from a fire that was not substantially vested unless you make the elec- If a debt you owe is canceled or forgiven, other covered by insurance on the building. You tion discussed later. Property becomes substan- than as a gift or bequest, you generally must claimed a deduction for this loss. You spent tially vested when your rights in the property or include the canceled amount in your gross in- $5,500 to repair the fire damages and extend the the rights of any person to whom you transfer come for tax purposes. A debt includes any useful life of the building. The adjusted basis of the property are not subject to a substantial risk indebtedness for which you are liable or which of forfeiture. the building on January 1, 2002, is figured as attaches to property you hold. follows: There is substantial risk of forfeiture when

You can exclude canceled debt from income the rights to full enjoyment of the property de- in the following situations. Original cost of building including pend on the future performance of substantial

fees and commissions ......... $72,275 services by any person. 1) Debt canceled in a bankruptcy case or Adjustments to basis: When the property becomes substantially when you are insolvent. Add: vested, include the FMV, less any amount you Improvements ............ 20,000 2) Qualified farm debt. paid for the property, in income. Repair of fire damages ...... 5,500

3) Qualified real property business debt (pro- $97,775 Example. Your employer gives you stock vided you are not a C corporation). Subtract: for services performed under the condition that Depreciation ....... $14,526 If you exclude from income canceled debt under you will have to return the stock unless you Deducted casualty loss 5,000 19,526 situation (1) or (2), you may have to reduce the complete 5 years of service. The stock is under

basis of your depreciable and nondepreciable a substantial risk of forfeiture and is not substan- Adjusted basis on January 1, 2002 $78,249

Page 6
tially vested when you receive it. You do not Money or property not similar or related. If To qualify as a like-kind exchange, you must

report any income until you have completed the you receive money or property not similar or hold for business or investment purposes both

5 years of service that satisfy the condition. related in service or use to the converted prop- the property you transfer and the property you

erty, and you buy replacement property similar receive. There must also be an exchange of

Fair market value. Figure the FMV of property or related in service or use to the converted like-kind property. For more information, see

you received without considering any restriction property, the basis of the new property is its cost Like-Kind Exchanges in Publication 544.

except one that by its terms will never end. decreased by the gain not recognized on the The basis of the property you receive is the conversion. same as the basis of the property you gave up. Example. You received stock from your employer for services you performed. If you want to Example. The state condemned your prop- Example. You exchange real estate (ad- sell the stock while you are still employed, you erty. The property had an adjusted basis of justed basis $50,000, FMV $80,000) held for must sell the stock to your employer at book $26,000 and the state paid you $31,000 for it. investment for other real estate (FMV $80,000) value. At your retirement or death, you or your You realized a gain of $5,000 ($31,000 − held for investment. Your basis in the new prop- estate must offer to sell the stock to your em- $26,000). You bought replacement property erty is the same as the basis of the old ployer at its book value. This is a restriction that similar in use to the converted property for ($50,000). by its terms will never end and you must con- $29,000. You recognize a gain of $2,000

sider it when you figure the FMV. ($31,000 − $29,000), the unspent part of the Exchange expenses. Exchange expenses payment from the state. Your gain not recog- are generally the closing costs you pay. They Election. You can choose to include in your nized is $3,000, the difference between the include such items as brokerage commissions, gross income the FMV of the property at the time $5,000 realized gain and the $2,000 recognized attorney fees, deed preparation fees, etc. Add of transfer, less any amount you paid for it. If you gain. The basis of the new property is figured as them to the basis of the like-kind property re- make this choice, the substantially vested rules follows: ceived. do not apply. Your basis is the amount you paid

plus the amount you included in income. Cost of replacement property ...... $29,000

Minus: Gain not recognized ....... 3,000 Property plus cash. If you trade property in a See the discussion of Restricted Property in

like-kind exchange and also pay money, the Publication 525 for more information. Basis of the replacement property $26,000 basis of the property received is the basis of the

property you gave up increased by the money Taxable Exchanges Allocating the basis. you paid. If you buy more than

A taxable exchange is one in which the gain is one piece of replacement property, allocate your

basis among the properties based on their re- Example. You trade in a truck (adjusted ba- taxable or the loss is deductible. A taxable gain spective costs. sis $3,000) for another truck (FMV $7,500) and or deductible loss is also known as a recognized pay $4,000. Your basis in the new truck is gain or loss. If you receive property in exchange Example. The state in the previous exam- $7,000 (the $3,000 basis of the old truck plus the for other property in a taxable exchange, the ple condemned your unimproved real property $4,000 paid). basis of property you receive is usually its FMV and the replacement property you bought was at the time of the exchange. A taxable exchange

occurs when you receive cash or property not improved real property with both land and build- Special rules for related persons. If a

ings. Allocate the replacement property’s like-kind exchange takes place directly or indi- similar or related in use to the property ex- $26,000 basis between land and buildings rectly between related persons and either party changed. based on their respective costs. disposes of the property within 2 years after the

Example. You trade a tract of farm land with exchange, the exchange no longer qualifies for

an adjusted basis of $3,000 for a tractor that has More information. For more information like-kind exchange treatment. Each person

an FMV of $6,000. You must report a taxable about condemnations, see Involuntary Conver- must report any gain or loss not recognized on

gain of $3,000 for the land. The tractor has a sions in Publication 544. For more information the original exchange. Each person reports it on

basis of $6,000. about casualty and theft losses, see Publication the tax return filed for the year in which the later

547. disposition occurs. If this rule applies, the basis

of the property received in the original exchange

Involuntary Conversions Nontaxable Exchanges will be its fair market value.

These rules generally do not apply to the If you receive property as a result of an involun- Terms you may need to know following kinds of property dispositions. tary conversion, such as a casualty, theft, or (see Glossary): condemnation, you can figure the basis of the 1) Dispositions due to the death of either re- replacement property you receive using the ba- Intangible property lated person. sis of the converted property.

Like-kind property 2) Involuntary conversions.

Similar or related property. If you receive Personal property 3) Dispositions in which neither the original replacement property similar or related in ser- exchange nor the subsequent disposition vice or use to the converted property, the re- Real property had as a main purpose the avoidance of placement property’s basis is the old property’s Tangible property federal income tax. basis on the date of the conversion. However,

make the following adjustments. Related persons. Generally, related per1) Decrease the basis by the following. A nontaxable exchange is an exchange in which sons are ancestors, lineal descendants, brothyou are not taxed on any gain and you cannot ers and sisters (whole or half), and a spouse.

a) Any loss you recognize on the conver- deduct any loss. If you receive property in a For other related persons (for example, two sion. nontaxable exchange, its basis is usually the corporations, an individual and a corporation, a same as the basis of the property you trans- b) Any money you receive that you do not grantor and fiduciary, etc.), see Nondeductible ferred. A nontaxable gain or loss is also known spend on similar property. Loss in chapter 2 of Publication 544. as an unrecognized gain or loss.

2) Increase the basis by the following. Exchange of business property. ExchangLike-Kind Exchanges ing the assets of one business for the assets of a) Any gain you recognize on the conver- another business is a multiple property ex- sion. The exchange of property for the same kind of change. For information on figuring basis, see

b) Any cost of acquiring the replacement property is the most common type of nontaxable Multiple Property Exchanges in chapter 1 of

property. exchange. Publication 544.

Page 7
Partially Nontaxable Exchange Allocate the total basis of $15,500 first to the the same as your basis for figuring a gain or loss

unlike property — the truck ($3,000). This is the on its sale.

A partially nontaxable exchange is an exchange truck’s FMV. The rest ($12,500) is the basis of For information on figuring your basis for in which you receive unlike property or money in the real estate. depreciation, see Publication 463. addition to like property. The basis of the property you receive is the same as the basis of the Property Transferred property you gave up, with the following adjust- Sale and Purchase

ments. From a Spouse

If you sell property and buy similar property in The basis of property transferred to you or trans- 1) Decrease the basis by the following two mutually dependent transactions, you may

have to treat the sale and purchase as a single ferred in trust for your benefit by your spouse (or amounts.

nontaxable exchange. former spouse if the transfer is incident to dia) Any money you receive. vorce), is the same as your spouse’s adjusted

Example. You are a salesperson and you basis. However, adjust your basis for any gain b) Any loss you recognize on the ex- use one of your cars 100% for business. You recognized by your spouse or former spouse on change. have used this car in your sales activities for 2 property transferred in trust. This rule applies

years and have depreciated it. Your adjusted only to a transfer of property in trust in which the 2) Increase the basis by the following basis in the car is $22,600 and its FMV is liabilities assumed, plus the liabilities to which amounts. $23,100. You are interested in a new car, which the property is subject, are more than the adsells for $28,000. If you trade your old car and justed basis of the property transferred. a) Any additional costs you incur.

pay $4,900 for the new one, your basis for de- If the property transferred to you is a series b) Any gain you recognize on the ex- preciation for the new car would be $27,500 E, series EE, or series I United States savings change. ($4,900 plus the $22,600 basis of your old car). bond, the transferor must include in income the

However, you want a higher basis for depreciat- interest accrued to the date of transfer. Your

If the other party to the exchange assumes ing the new car, so you agree to pay the dealer basis in the bond immediately after the transfer your liabilities, treat the debt assumption as $28,000 for the new car if he will pay you is equal to the transferor’s basis increased by money you received in the exchange. $23,100 for your old car. Because the two trans- the interest income includible in the transferor’s

actions are dependent on each other, you are income. For more information on these bonds, Example. You traded a truck (adjusted ba- treated as having exchanged your old car for the see Publication 550. sis $6,000) for a new truck (FMV $5,200) and new one and paid $4,900 ($28,000 − $23,100). At the time of the transfer, the transferor $1,000 cash. You realized a gain of $200 Your basis for depreciating the new car is must give you the records necessary to deter- ($6,200 − $6,000). This is the FMV of the truck $27,500, the same as if you traded the old car. mine the adjusted basis and holding period of received plus the cash minus the adjusted basis the property as of the date of transfer. of the truck you traded ($5,200 + $1,000 – For more information, see Publication 504, $6,000). You include all the gain in income (rec- Partial Business Use of Property Divorced or Separated Individuals. ognized gain) because the gain is less than the

cash received. Your basis in the new truck is: If you have property used partly for business and

partly for personal use, and you exchange it in a Property

Adjusted basis of old truck ........ $6,000 nontaxable exchange for property to be used Received as a Gift

Minus: Cash received (adjustment wholly or partly in your business, the basis of the 1(a)) ..................... 1,000 property you receive is figured as if you had To figure the basis of property you receive as a

$5,000 exchanged two properties. The first is an ex- gift, you must know its adjusted basis (defined Plus: Gain recognized (adjustment change of like-kind property. The second is earlier) to the donor just before it was given to 2(b)) . . . . . . . . . . . . . . . . . . . . . 200 personal-use property on which gain is recog- you, its FMV at the time it was given to you, and

Basis of new truck nized and loss is not recognized. any gift tax paid on it. ............ $5,200

First, figure your adjusted basis in the property as if you transferred two separate proper- Allocation of basis. Allocate the basis first to ties. Figure the adjusted basis of each part of the FMV Less Than

the unlike property, other than money, up to its property by taking into account any adjustments Donor’s Adjusted Basis FMV on the date of the exchange. The rest is the to basis. Deduct the depreciation you took or basis of the like property. If the FMV of the property at the time of the gift is could have taken from the adjusted basis of the less than the donor’s adjusted basis, your basis business part. Then figure the amount realized Example. You had an adjusted basis of depends on whether you have a gain or a loss for your property and allocate it to the business $15,000 in real estate you held for investment. when you dispose of the property. Your basis for and nonbusiness parts of the property. You exchanged it for other real estate to be held figuring gain is the same as the donor’s adjusted The business part of the property is permit- for investment with an FMV of $12,500, a truck basis plus or minus any required adjustment to ted to be exchanged tax free. However, you with an FMV of $3,000, and $1,000 cash. The basis while you held the property. Your basis for must recognize any gain from the exchange of truck is unlike property. You realized a gain of figuring loss is its FMV when you received the the nonbusiness part. You are deemed to have $1,500 ($16,500 − $15,000). This is the FMV of gift plus or minus any required adjustment to received, in exchange for the nonbusiness part, the real estate received plus the FMV of the basis while you held the property (see Adjusted an amount equal to its FMV on the date of the truck received plus the cash minus the adjusted Basis, earlier). exchange. The basis of the property you ac- basis of the real estate you traded ($12,500 + If you use the donor’s adjusted basis for quired is the total basis of the property trans- $3,000 + $1,000 – $15,000). You include in figuring a gain and get a loss, and then use the ferred (adjusted to the date of the exchange), income (recognize) all $1,500 of the gain be- FMV for figuring a loss and have a gain, you increased by any gain recognized on the non- cause it is less than the FMV of the unlike prop- have neither gain nor loss on the sale or disposi- business part. erty plus the cash received. Your basis in the tion of the property.

properties you received is figured as follows. If the nonbusiness part of the property

transferred is your main home, you Example. You received an acre of land as a

Adjusted basis of real estate may qualify to exclude from income all gift. At the time of the gift, the land had an FMV

TIP

transferred ................ $15,000 or part of the gain on that part. For more informa- of $8,000. The donor’s adjusted basis was Minus: Cash received (adjustment tion, see Publication 523. $10,000. After you received the land, no events 1(a)) .................... 1,000 occurred to increase or decrease your basis. If $14,000 Trade of car used partly in business. If you you sell the land for $12,000, you will have a Plus: Gain recognized (adjustment trade in a car you used partly in your business $2,000 gain because you must use the donor’s 2(b)) .................... 1,500 for another car you will use in your business, adjusted basis ($10,000) at the time of the gift as

Total basis of properties received $15,500 your basis for depreciation of the new car is not your basis to figure gain. If you sell the land for

Page 8
$7,000, you will have a $1,000 loss because you $50,000 (half of the $100,000 FMV). The basis Fair market value ............ $50,000

must use the FMV ($8,000) at the time of the gift Minus: Adjusted basis ......... 20,000 of the other half to your spouse’s heirs is also

as your basis to figure a loss. Net increase in value ......... $30,000 $50,000.

If the sales price is between $8,000 and Gift tax paid ............... $9,000 For more information on community prop- $10,000, you have neither gain nor loss. For Multiplied by ($30,000 ÷ $39,000) .77 erty, see Publication 555, Community Property. Gift tax due to net increase in value $6,930 instance, if the sales price was $9,000 and you Adjusted basis of property to your tried to figure a gain using the donor’s adjusted mother ................. 20,000 basis ($10,000), you would get a $1,000 loss. If Property Held by Surviving Tenant Your basis in the property ..... $26,930 you then tried to figure a loss using the FMV

($8,000), you would get a $1,000 gain. The following example explains the rule for the

basis of property held by a surviving tenant in Business property. If you hold the gift as Inherited Property joint tenancy or tenancy by the entirety. business property, your basis for figuring any Your basis in property you inherit from a dece- depreciation, depletion, or amortization deduc- dent is generally one of the following. Example. John and Jim owned, as joint te- tion is the same as the donor’s adjusted basis nants with right of survivorship, business prop- plus or minus any required adjustments to basis 1) The FMV of the property at the date of the erty they purchased for $30,000. John furnished while you hold the property. individual’s death. two-thirds of the purchase price and Jim furnished one-third. Depreciation deductions al- 2) The FMV on the alternate valuation date if FMV Equal to or More Than lowed before John’s death were $12,000. Under the personal representative for the estate Donor’s Adjusted Basis local law, each had a half interest in the income chooses to use alternate valuation. For infrom the property. At the date of John’s death, formation on the alternate valuation date, If the FMV of the property is equal to or greater the property had an FMV of $60,000, two-thirds see the instructions for Form 706. than the donor’s adjusted basis, your basis is the of which is includable in John’s estate. Jim

donor’s adjusted basis at the time you received 3) The value under the special-use valuation figures his basis in the property at the date of the gift. Increase your basis by all or part of any method for real property used in farming or John’s death as follows: gift tax paid, depending on the date of the gift. a closely held business if chosen for estate

Also, for figuring gain or loss from a sale or tax purposes. This method is discussed Interest Jim bought with his other disposition of the property, or for figuring later. own funds—1

/3 of $30,000

depreciation, depletion, or amortization deduc- cost ............... $10,000 4) The decedent’s adjusted basis in land to tions on business property, you must increase or Interest Jim received on the extent of the value excluded from the decrease your basis by any required adjust- John’s death—2

/3 of decedent’s taxable estate as a qualified ments to basis while you held the property. See $60,000 FMV ......... 40,000 $50,000 conservation easement. For information on Adjusted Basis, earlier. Minus: 1

/2 of $12,000 depreciation a qualified conservation easement, see the before John’s death ........... 6,000 Gift received before 1977. If you received a instructions to Form 706.

gift before 1977, increase your basis in the gift Jim’s basis at the date of John’s

(the donor’s adjusted basis) by any gift tax paid If a federal estate tax return does not have to death .................... $44,000

be filed, your basis in the inherited property is its on it. However, do not increase your basis above appraised value at the date of death for state If Jim had not contributed any part of the the FMV of the gift at the time it was given to you. inheritance or transmission taxes. purchase price, his basis at the date of John’s

death would be $54,000. This is figured by sub- Example 1. You were given a house in 1976

with an FMV of $21,000. The donor Appreciated property. The above rule does tracting from the $60,000 FMV, the $6,000 de- ’s adjusted

basis was $20,000. The donor paid a gift tax of not apply to appreciated property you receive preciation allocated to Jim’s half interest before

the date of death. $500. Your basis is $20,500, the donor’s ad- from a decedent if you or your spouse originally

justed basis plus the gift tax paid. gave the property to the decedent within 1 year If under local law Jim had no interest in the

before the decedent’s death. Your basis in this income from the property and he contributed no

Example 2. If, in Example 1, the gift tax paid property is the same as the decedent’s adjusted part of the purchase price, his basis at John’s

had been $1,500, your basis would be $21,000. basis in the property immediately before his or death would be $60,000, the FMV of the propThis is the donor’s adjusted basis plus the gift her death, rather than its FMV. Appreciated erty. tax paid, limited to the FMV of the house at the property is any property whose FMV on the day

time you received the gift. it was given to the decedent is more than its

Gift received after 1976. adjusted basis. Qualified Joint Interest If you received a gift

after 1976, increase your basis in the gift (the Include one-half of the value of a qualified joint donor’s adjusted basis) by the part of the gift tax Community Property interest in the decedent’s gross estate. It does paid on it that is due to the net increase in value not matter how much each spouse contributed of the gift. Figure the increase by multiplying the In community property states (Arizona, Califor- to the purchase price. Also, it does not matter gift tax paid by a fraction. The numerator of the nia, Idaho, Louisiana, Nevada, New Mexico, which spouse dies first. fraction is the net increase in value of the gift and Texas, Washington, and Wisconsin), husband the denominator is the amount of the gift. A qualified joint interest is any interest in and wife are each usually considered to own half The net increase in value of the gift is the property held by husband and wife as either of the community property. When either spouse FMV of the gift less the donor’s adjusted basis. the following. dies, the total value of the community property, The amount of the gift is its value for gift tax even the part belonging to the surviving spouse, • Tenants by the entirety. purposes after reduction by any annual exclu- generally becomes the basis of the entire prop- sion and marital or charitable deduction that • Joint tenants with right of survivorship if erty. For this rule to apply, at least half the value applies to the gift. For information on the gift tax, husband and wife are the only joint te- of the community property interest must be in- see Publication 950, Introduction to Estate and nants. cludable in the decedent’s gross estate, whether Gift Taxes.

or not the estate must file a return.

For example, you and your spouse owned Basis. As the surviving spouse, your basis in Example. In 2002, you received a gift of

community property that had a basis of $80,000. property you owned with your spouse as a quali- property from your mother that had an FMV of

$50,000. Her adjusted basis was $20,000. The When your spouse died, half the FMV of the fied joint interest is the cost of your half of the

amount of the gift for gift tax purposes was community interest was includible in your property with certain adjustments. Decrease the

$39,000 ($50,000 minus the $11,000 annual spouse’s estate. The FMV of the community cost by any deductions allowed to you for depreexclusion). She paid a gift tax of $9,000. Your interest was $100,000. The basis of your half of ciation and depletion. Increase the reduced cost

basis, $26,930, is figured as follows: by your basis in the half you inherited. the property after the death of your spouse is

Page 9
Farm or Closely Held Business Basis for depreciation. The basis for depre- unsuccessfully, you should contact your Taxciation is the lesser of the following amounts. payer Advocate.

Under certain conditions, when a person dies The Taxpayer Advocate represents your inthe executor or personal representative of that • The FMV of the property on the date of the terests and concerns within the IRS by protectperson change. ’s estate can choose to value the quali- ing your rights and resolving problems that have

fied real property on other than its FMV. If so, the • Your adjusted basis on the date of the not been fixed through normal channels. While

executor or personal representative values the change. Taxpayer Advocates cannot change the tax law

qualified real property based on its use as a farm or make a technical tax decision, they can clear

or its use in a closely held business. If the execu- up problems that resulted from previous con- Example. Several years ago you paid tor or personal representative chooses this tacts and ensure that your case is given a commethod of valuation for estate tax purposes, that $160,000 to have your home built on a lot that plete and impartial review. cost $25,000. You paid $20,000 for permanent value is the basis of the property for the heirs. To contact your Taxpayer Advocate:

Qualified heirs should be able to get the neces- improvements to the house and claimed a

$2,000 casualty loss deduction for damage to • Call the Taxpayer Advocate at sary value from the executor or personal repre- 1–877–777–4778. the house before changing the property to rental sentative of the estate.

use last year. Because land is not depreciable, • Call the IRS at 1–800–829–1040.

you include only the cost of the house when Special-use valuation. If you are a qualified figuring the basis for depreciation. • Call, write, or fax the Taxpayer Advocate heir who received special-use valuation prop- Your adjusted basis in the house when you office in your area. erty, your basis in the property is the estate’s or

trust’s basis in that property immediately before changed its use was $178,000 ($160,000 + • Call 1–800–829–4059 if you are a

the distribution. Increase your basis by any gain $20,000 − $2,000). On the same date, your TTY/TDD user.

property had an FMV of $180,000, of which recognized by the estate or trust because of

post-death appreciation. Post-death apprecia- $15,000 was for the land and $165,000 was for For more information, see Publication 1546,

the house. The basis for figuring depreciation on The Taxpayer Advocate Service of the IRS. tion is the property’s FMV on the date of distributhe house is its FMV on the date of change tion minus the property’s FMV either on the date

($165,000) because it is less than your adjusted Free tax services. To find out what services of the individual’s death or the alternate valuabasis ($178,000). are available, get Publication 910, Guide to Free tion date. Figure all FMVs without regard to the Tax Services. It contains a list of free tax publi- special-use valuation. Sale of property. If you later sell or dispose of cations and an index of tax topics. It also de- You can elect to increase your basis in property changed to business or rental use, the scribes other free tax information services, special-use valuation property if it becomes sub- basis of the property you use will depend on including tax education and assistance pro- ject to the additional estate tax. This tax is as- whether you are figuring gain or loss. grams and a list of TeleTax topics. sessed if, within 10 years after the death of the

decedent, you transfer the property to a person Gain. The basis for figuring a gain is your Personal computer. With your perwho is not a member of your family or the prop- adjusted basis when you sell the property. sonal computer and modem, you can

access the IRS on the Internet at erty stops being used as a farm or in a closely

Example. Assume the same facts as in the www.irs.gov. While visiting our web site, you held business.

previous example except that you sell the prop- can: To increase your basis in the property, you

must make an irrevocable election and pay in- erty at a gain after being allowed depreciation • Find answers to questions you may have. deductions of $37,500. Your adjusted basis for terest on the additional estate tax figured from • Download forms and publications or figuring gain is $165,500 ($178,000 + $25,000 the date 9 months after the decedent’s death

(land) − $37,500). search for forms and publications by topic until the date of the payment of the additional or keyword. estate tax. If you meet these requirements, in- Loss. Figure the basis for a loss starting

crease your basis in the property to its FMV on with the smaller of your adjusted basis or the • View forms that may be filled in electronithe date of the decedent’s death or the alternate FMV of the property at the time of the change to cally, print the completed form, and then

valuation date. The increase in your basis is business or rental use. Then adjust this amount save the form for recordkeeping.

considered to have occurred immediately before for the period after the change in the property’s • View Internal Revenue Bulletins published the event that results in the additional estate tax. use, as discussed earlier under Adjusted Basis, in the last few years. You make the election by filing with Form to arrive at a basis for loss.

706-A a statement that does all of the following. • Search regulations and the Internal ReveExample. Assume the same facts as in the nue Code.

1) Contains your name, address, and tax- previous example, except that you sell the prop- • Receive our electronic newsletters on hot payer identification number and those of erty at a loss after being allowed depreciation tax issues and news. the estate. deductions of $37,500. In this case, you would

start with the FMV on the date of the change to • Get information on starting and operating 2) Identifies the election as an election under a small business. rental use ($180,000) because it is less than the section 1016(c) of the Internal Revenue adjusted basis of $203,000 ($178,000 + Code. You can also reach us with your computer $25,000) on that date. Reduce that amount

3) Specifies the property for which the elec- using File Transfer Protocol at ftp.irs.gov. ($180,000) by the depreciation deductions to

tion is made. arrive at a basis for loss of $142,500 ($180,000 TaxFax Service. Using the phone at- − $37,500). 4) Provides any additional information re- tached to your fax machine, you can quired by the Form 706-A instructions. receive forms and instructions by callFor more information, see the instructions to ing 703–368–9694. Follow the directions from

Form 706 and Form 706-A. the prompts. When you order forms, enter the How To Get Tax Help catalog number for the form you need. The items

Property Changed to you request will be faxed to you. You can get help with unresolved tax issues, For help with transmission problems, call the Business or Rental Use order free publications and forms, ask tax ques- FedWorld Help Desk at 703–487–4608. tions, and get more information from the IRS in

If you hold property for personal use and then several ways. By selecting the method that is Phone. Many services are available by change it to business use or use it to produce best for you, you will have quick and easy ac- phone. rent, you must figure its basis for depreciation. cess to tax help.

An example of changing property held for personal use to business use would be renting out Contacting your Taxpayer Advocate. If you • Ordering forms, instructions, and publicayour former main home. have attempted to deal with an IRS problem tions. Call 1–800–829–3676 to order curPage 10
rent and prior year forms, instructions, and only evaluates the IRS assistor and does • Prior-year tax forms and instructions.

publications. not keep a record of any taxpayer’s name • Popular tax forms that may be filled in or tax identification number. • Asking tax questions. Call the IRS with electronically, printed out for submission,

your tax questions at 1–800–829–1040. • We sometimes record telephone calls to and saved for recordkeeping.

evaluate IRS assistors objectively. We • TTY/TDD equipment. If you have access • Internal Revenue Bulletins. hold these recordings no longer than one to TTY/TDD equipment, call 1–800–829– week and use them only to measure the 4059 to ask tax questions or to order The CD-ROM can be purchased from Na- quality of assistance. forms and publications. tional Technical Information Service (NTIS) by

• We value our customers’ opinions. calling 1–877–233–6767 or on the Internet at • TeleTax topics. Call 1–800–829–4477 to Throughout this year, we will be surveying www.irs.gov. The first release is available in listen to pre-recorded messages covering our customers for their opinions on our mid-December and the final release is available various tax topics. service. in late January.

IRS Publication 3207, Small Business ReEvaluating the quality of our telephone ser- source Guide, is an interactive CD-ROM that CD-ROM. You can order IRS Publica- vices. To ensure that IRS representatives contains information important to small busi- tion 1796, Federal Tax Products on give accurate, courteous, and professional an- nesses. It is available in mid-February. You can CD-ROM, and obtain: swers, we evaluate the quality of our telephone get a free copy by calling 1–800–829–3676 or

services in several ways. • Current tax forms, instructions, and publi- visiting the IRS web site at www.irs.gov.

cations. • A second IRS representative sometimes

monitors live telephone calls. That person

Glossary

The definitions in this glossary the extraction and sale of the min- expected continued customer pa- Section 179 deduction: This is a

are the meanings of the terms as erals or the cutting of the timber. special deduction allowed against tronage due to its name, reputaused in this publication. The same tion, or any other factor. the cost of certain property pur- Depreciation: Ratable deduction chased for use in the active con- term used in another publication

may have a slightly different mean- allowed over a number of years to Intangible property: Property duct of a trade or business.

recover your basis in property that that cannot be perceived by the ing. is used more than one year for senses such as goodwill, patents, Section 197 intangibles: CerAmortization: A ratable deduc- business or income producing pur- tain intangibles held in connection copyrights, etc.

poses. with the conduct of a trade or busi- tion for the cost of certain intangible Like-kind property: Items of ness or an activity entered into for property over the period specified Fair market value (FMV): FMV property with the same nature or profit, including goodwill, going by law. Examples of costs that can is the price at which property would character. The grade or quality of concern value, patents, copyrights, be amortized are goodwill, agree- change hands between a buyer the properties does not matter. Ex- formulas, franchises, trademarks, ment not to compete, and research and a seller, neither having to buy amples are two vacant plots of and trade names. and mining exploration costs. or sell, and both having reasonable land.

knowledge of all necessary facts. Tangible property: This is prop- Business assets: Property used Personal property: Property, erty that can be seen or touched, in the conduct of a trade or busi- Going concern value: Going such as machinery, equipment, or such as furniture and buildings. ness, such as business machinery concern value is the additional furniture, that is not real property.

and office furniture. value that attaches to property be- Unstated interest: The part of

cause the property is an integral the sales price treated as interest Real property: Land and generCapitalization: Adding costs, part of an ongoing business activ- when an installment contract pro- ally anything erected on, growing

such as improvements, to the basis ity. It includes value based on the vides for little or no interest. on, or attached to land, for examof assets. ability of a business to continue to ple, a building.

function and generate income even Depletion: Yearly deduction al- Recapture: Amount of deprecia- though there is a change in owner- lowed to recover your investment in tion or section 179 deduction that ship. minerals in place or standing tim- must be reported as ordinary inber. To take the deduction, you Goodwill: Goodwill is the value come when property is sold at a

must have the right to income from of a trade or business based on gain.

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Index

A Comments .............. 2 Group of assets acquired .... 4 Publications (See Tax help)

Adjusted basis: Community property ........ 9

Adoption tax benefits ...... 6 Constructing assets ........ 3 H R

Assessment for local Copyrights .............. 4 Help (See Tax help) Real estate taxes .......... 2

improvements ......... 5 Cost basis: Real property ............ 2 Canceled debt .......... 6 Allocating basis ......... 4

Casualty and theft losses . . . 5 I Assumption of mortgage . . . 3 Clean-fuel vehicle refueling Inherited property ......... 9 S Capitalized costs . . . . . . 3, 5

property ............. 5 Intangible assets .......... 3 Settlement costs (fees) ...... 2 Loans, low or no interest . . . 2 Clean-fuel vehicles ....... 5 Real estate taxes ........ 2 Involuntary exchanges ...... 7 Special-use valuation . . . . . . 10

Credit for qualified electric Real property ........... 2 Spouse, property transferred

vehicles ............. 5 Settlement costs (fees) .... 2 L from ................. 8

Decreases to ........... 5 Stocks and bonds ......... 2 Land and buildings ......... 4 Depreciation ........... 6 D Subdivided lots ........... 4 Easements Loans, low or no interest ..... 2 ............ 5

Decreases to basis Suggestions ............. 2 Employer-provided child ........ 5

care ............... 6 Demolition of building ....... 4 M

Example .............. 6 Depreciation ............. 6 More information (See Tax help) T

Gain from sale of home .... 6 Tax help . . . . . . . . . . . . . . . 10

Gas-guzzler tax ......... 5 E Taxable exchanges ........ 7

Increases to ............ 4 N

Easements Taxpayer Advocate . . . . . . . 10

Section 179 deduction .............. 5 Nontaxable exchanges: ..... 5

Employer-provided child care . . 6 Trade or business acquired . . . 4 Subsidies for energy Like-kind .............. 7

Exchanges: Trademarks and trade conservation .......... 6 Partial ................ 8 names ............... 4 Involuntary ............ 7 Adoption tax benefits ....... 6

Like-kind .............. 7 Trading property (see Allocating basis ........... 4 P Nontaxable ............ 7 Exchanges) ............ 7

Assistance (See Tax help) Partially nontaxable Partial business use of TTY/TDD information . . . . . . 10

Assumption of mortgage ..... 3 exchanges ............ 8 property ............. 8

Patents ................ 3 Taxable .............. 7 U B Points ................. 3

Uniform capitalization rules: Property changed to Business acquired ......... 4 F Activities subject to the business use . . . . . . . . . . 10 Business assets .......... 3 Fair market value .......... 6 rules ............... 3 Property received as a gift .... 8 Businesses exchanged ...... 7 Franchises .............. 4 Exceptions ............ 3

Property received for services: Free tax services . . . . . . . . . 10 Bargain purchases ....... 6 ■

C Fair market value ........ 6

Canceled debt ............ 6 G Restricted property ....... 6

Casualty and theft losses .... 5 Gain from sale of home ..... 6 Property transferred from a

Change to business use . . . . 10 Gifts, property received ...... 8 spouse ............... 8

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