The word ‘basis’ can mean different things in different settings, but for the IRS, it generally relates to the cost of your property. However, the tax code connects basis to three distinct scenarios, and here’s what you need to know!
How the IRS Defines Basis
The main reason why it’s important to understand “basis” as an IRS term is because it affects the taxes you pay in relation to property ownership. Whenever you sell, exchange, or give away property, the amount of your capital investment in the property must be accounted for. Put simply, basis is how the tax code defines the cost of your property.
That basis figure is then used to calculate depreciation, amortization, depletion, casualty losses, and any gain or loss in the property transaction. This could be selling the property, exchanging property, or any other disposition of the property. All of those situations will require a number for your property basis in order to determine how to handle specific aspects of your upcoming tax return.
The 3 Types of Basis for Your Taxes
Knowing that basis relates to the cost of your property, it’s sometimes helpful to dive a little deeper and look at the various types of basis that the IRS needs to reference.
Cost Basis
When the IRS talks about the “cost basis,” they aren’t just considering what the item cost. The cost basis also includes sales tax paid, freight, legal fees, installation, and other fees that might have been paid in the purchase of the property. This can be very detailed!
For example, when someone acquires a business, the cost basis often needs to be allocated to each one of the assets in the business to determine their actual basis in connection to the purchase price. That’s why it’s helpful to hold on to records for major transactions. Knowing how to apply costs to your basis can help reduce taxes when you sell or dispose of the property down the road.
Adjusted Basis
Have you made any major improvements to your home recently? Understanding your adjusted basis could help you when it’s time to sell. A common example of adjusted basis is when you’ve made capital improvements to a property. Selling, exchanging, or disposing of that property may require you to adjust its basis to make sure that those upgrades are included, whether that’s a roof replacement, adding a new room, or other smaller improvements.
It’s worth noting, though, that adjusted basis can sometimes decrease the value of property. This can happen because of theft losses. Running the numbers for all aspects of your property’s value can help you anticipate what your capital gain might be when you sell!
Basis Other Than Cost
You might also be in a situation where you receive property for services or as a gift. In most cases, the basis will be determined by the item’s fair market value. However, there are special basis rules for inherited property, like-kind property exchanges, and property transferred to a spouse. Reviewing your circumstances is always crucial for establishing basis. You don’t want to end up owing more on your taxes than what’s fair. A quick conversation might be all you need to get back on track.
Got Questions About Tax Terminology? We Can Help!
The tax code is complex and ever-changing, so it’s always nice to know that you don’t have to work through your questions on your own. Whenever you have questions about tax terminology or how to handle the sale or purchase of property, please know that we can help!
NSO & Company is proud to serve small businesses, families, and individual taxpayers throughout the state of Indiana and beyond. We’re based in Fishers, Indiana and are always just a phone call away: (317) 588-3131.