What does “basis” mean in the world of tax? Tax basis of an asset is generally its cost. Determining accurate cost may require allocations when multiple assets are purchased together.
Tax basis may also be reduced by depreciation, depletion, casualty losses and a number of other factors. This reduced basis is referred to as the adjusted tax basis.
There are a number of reasons why tax professionals may need basis. It is used to calculate:
- Bad debt deduction
- Casualty loss deductions
- Gain or loss on disposition
Determining Tax Basis
The basis of property is generally the amount paid for the property in cash and/or other property. Sometimes the taxpayer may trade a piece of equipment in addition to giving cash for the property.
When an asset is purchased, tax basis generally includes cash paid plus liabilities assumed. For example, if Russell acquires a building for $10,000 cash and assumes a mortgage for $80,000, which is his assumed liability, then his basis in the building is $90,000. If multiple items of property are purchased together in a single transaction, the tax basis must generally be allocated to the items in proportion to their fair market values at the time of acquisition. As you will see later, fair market value may be different depending on the date purchased or placed in service.
Fungible property such as bushels of wheat, or shares of corporation stock or mutual funds with reinvested dividends may include property acquired at different times with differing bases. If this type of property is sold, the taxpayer may need to use an assumption, such as average cost or first in first out, to determine the cost of the portion of the property that was sold.
When a taxpayer purchases a business, he either purchases the stock from the previous owner or purchases the assets of the business.
If the assets are purchased, the purchase price must be allocated in a reasonable manner between furniture, equipment, machinery, land and buildings, as well as IRC Section 197 intangibles, including goodwill and/or client list. Form 8594, Asset Acquisition Statement, must be filed with the tax return of the purchaser and the seller. It is important to note that self-created goodwill is not a Section 197 asset; only acquired (purchased) goodwill is.
The tax basis of an asset subject to cost recovery must be reduced by deductions allowed for depreciation or depletion. For example, if Russell claimed $25,000 of depreciation on his building, his adjusted basis would be the $90,000 purchase price, less $25,000 depreciation, for a net adjusted basis of $65,000. Cost recovery deductions may include depreciation, amortization and deducted losses.
I hope this article helped explain the basics of basis. Stay tuned to the Intuit® ProConnect™ Tax Pro Center for the rest of my series on basis to learn more.