Publication 551 |
2001 Tax Year |
Cost Basis
Words you may need to know (see Glossary):
- Business assets
- Nonbusiness assets
- Real property
- Unstated interest
The basis of property you buy is usually its cost. The cost is the
amount you pay in cash, debt obligations, other property, or services.
Your cost also includes amounts you pay for the following items.
- Sales tax.
- Freight.
- Installation and testing.
- Excise taxes.
- Legal and accounting fees (when they must be
capitalized).
- Revenue stamps.
- Recording fees.
- Real estate taxes (if assumed for the seller).
You may also have to capitalize certain other costs related to
buying or producing property.
Loans with low or no interest.
If you buy property on any time-payment plan that charges little or
no interest, the basis of your property is your stated purchase price,
minus the amount considered to be unstated interest. You generally
have unstated interest if your interest rate is less than the
applicable federal rate. See the discussion of unstated interest in
Publication 537.
Purchase of a business.
When you purchase a trade or business, you generally purchase all
assets used in the business operations, such as land, buildings, and
machinery. Spread the price among the various assets including any
section 197 intangibles, such as goodwill. See Allocating the
Basis, later.
Stocks and Bonds
The basis of stocks or bonds you buy is generally the purchase
price plus any costs of purchase, such as commissions and recording or
transfer fees. If you get stocks or bonds other than by purchase, your
basis is usually determined by the fair market value (FMV) or the
previous owner's adjusted basis.
You must adjust the basis of stocks for certain events that occur
after purchase. See Stocks and Bonds in chapter 4 of
Publication 550
for more information on basis.
Identifying stock or bonds sold.
If you can adequately identify the shares of stock or the bonds you
sold, their basis is the cost or other basis of the particular shares
of stock or bonds. If you buy and sell securities at various times in
varying quantities and you cannot adequately identify the shares you
sell, the basis of the securities you sell is the basis of the
securities you acquired first. For more information about identifying
securities you sell, see Stocks and Bonds under Basis
of Investment Property in chapter 4 of Publication 550.
Mutual fund shares.
If you sell mutual fund shares acquired at different times and
prices, you can choose to use an average basis. For more information,
see Average Basis in Publication 564.
Real Property
If you buy real property, certain fees and other expenses become
part of your cost basis in the property.
Real estate taxes.
If you pay the real estate taxes the seller owed on real property
you bought, and the seller did not reimburse you, treat those taxes as
part of your basis. You cannot deduct them as taxes.
If you reimburse the seller for taxes the seller paid for you, you
can usually deduct that amount as an expense in the year of purchase.
Do not include that amount in the basis of the property. If you did
not reimburse the seller, you must reduce your basis by the amount of
those taxes.
Settlement costs.
You can include in the basis of property you buy the settlement
fees and closing costs that are for buying the property. You cannot
include fees and costs for getting a loan on the property. (A fee for
buying property is a cost that must be paid even if you bought the
property for cash.)
The following items are some of the settlement fees or closing
costs you can include in the basis of your property.
- Abstract fees (abstract of title fees).
- Charges for installing utility services.
- Legal fees (including title search and preparation of the
sales contract and deed).
- Recording fees.
- Surveys.
- Transfer taxes.
- Owner's title insurance.
- Any amounts the seller owes that you agree to pay, such as
back taxes or interest, recording or mortgage fees, charges for
improvements or repairs, and sales commissions.
Settlement costs do not include amounts placed in escrow
for the future payment of items such as taxes and insurance.
The following items are some settlement fees and closing costs you
cannot include in the basis of the property.
- Fire insurance premiums.
- Rent for occupancy of the property before closing.
- Charges for utilities or other services related to occupancy
of the property before closing.
- Charges connected with getting a loan. The following are
examples of these charges.
- Points (discount points, loan origination fees).
- Mortgage insurance premiums.
- Loan assumption fees.
- Cost of a credit report.
- Fees for an appraisal required by a lender.
- Fees for refinancing a mortgage.
If these costs relate to business property, items (1) through
(3) are deductible as business expenses. Items (4) and (5) must be
capitalized as costs of getting a loan and can be deducted over the
period of the loan.
Points.
If you pay points to obtain a loan (including a mortgage, second
mortgage, line of credit, or a home equity loan), do not add the
points to the basis of the related property. Generally, you deduct the
points over the term of the loan. For more information on how to
deduct points, see Points in chapter 5 of Publication 535.
Points on home mortgage.
Special rules may apply to points you and the seller pay when you
obtain a mortgage to purchase your main home. If certain requirements
are met, you can deduct the points in full for the year in which they
are paid. Reduce the basis of your home by any seller-paid points. For
more information, see Points in Publication 936,
Home
Mortgage Interest Deduction.
Assumption of mortgage.
If you buy property and assume (or buy subject to) an existing
mortgage on the property, your basis includes the amount you pay for
the property plus the amount to be paid on the mortgage.
Example.
If you buy a building for $20,000 cash and assume a mortgage of
$80,000 on it, your basis is $100,000.
Constructing assets.
If you build property or have assets built for you, your expenses
for this construction are part of your basis. Some of these expenses
include the following items.
- The cost of land.
- The cost of labor and materials.
- Architect's fees.
- Building permit charges.
- Payments to contractors.
- Payments for rental equipment.
- Inspection fees.
In addition, if you own a business and use your employees,
material, and equipment to build an asset, your basis would also
include the following costs.
- Employee wages paid for the construction work.
- Depreciation on equipment you own while it is used in the
construction.
- Operating and maintenance costs for equipment used in the
construction.
- The cost of business supplies and materials used in the
construction.
Do not deduct these expenses. You must capitalize them (include
them in the asset's basis). Also, reduce your basis by any work
opportunity credit, welfare-to-work credit, Indian employment credit,
or empowerment zone employment credit allowable on the wages you pay
in (1), above. For information about these credits, see Publication 954,
Tax Incentives for Empowerment Zones and Other Distressed
Communities.
Do not include the value of your own labor, or any other labor you
did not pay for, in the basis of any property you construct.
Business Assets
Words you may need to know (see Glossary):
- Amortization
- Capital assets
- Capital expenses
- Capitalization
- Depletion
- Depreciation
- Fair market value
- Going concern value
- Goodwill
- Intangible property
- Personal property
- Recapture
- Section 179 deduction
- Section 197 intangibles
- Tangible property
If you purchase property to use in your business, your basis is
usually its actual cost to you. If you construct, create, or otherwise
produce property, you must capitalize the costs as your basis. In
certain circumstances, you may be subject to the uniform
capitalization rules, next.
Uniform Capitalization Rules
The uniform capitalization rules specify the costs you add to basis
in certain circumstances.
Who must use.
You must use the uniform capitalization rules if you do any of the
following in your trade or business or activity carried on for profit.
- Produce real or tangible personal property for use in the
business or activity.
- Produce real or tangible personal property for sale to
customers.
- Acquire property for resale.
You produce property if you construct, build, install, manufacture,
develop, improve, create, raise or grow the property. Treat the
property produced for you under a contract as produced by you up to
the amount you pay or costs you otherwise incur for the property.
Tangible personal property includes films, sound recordings, video
tapes, books, or similar property.
Under the uniform capitalization rules, you must capitalize all
direct costs and an allocable part of most indirect costs you incur
due to your production or resale activities. The term capitalize
means to include certain expenses in the basis of property you produce
or in your inventory costs rather than deduct them as a current
expense. You can recover these costs through depreciation,
amortization, or cost of goods sold when you use, sell, or otherwise
dispose of the property.
Any cost that you could not use to figure your taxable income for
any tax year is not subject to the uniform capitalization rules.
Example.
If you incur a business meal expense for which your deduction would
be limited to 50% of the cost of the meal, that amount is subject to
the uniform capitalization rules. The part of the cost that is not
deductible is not subject to the uniform capitalization rules.
More information.
For more information about these rules, see the regulations under
section 263A of the Internal Revenue Code and Publication 538,
Accounting Periods and Methods.
Exceptions.
The following are not subject to the uniform capitalization rules.
- Property you produce that you do not use in your trade,
business, or activity conducted for profit.
- Qualified creative expenses you pay or incur as a free-lance
(self-employed) writer, photographer, or artist that are otherwise
deductible on your tax return.
- Property you produce under a long-term contract, except for
certain home construction contracts.
- Research and experimental expenses allowable as a deduction
under section 174 of the Internal Revenue Code.
- Costs for personal property acquired for resale if your (or
your predecessor's) average annual gross receipts for the 3 previous
tax years do not exceed $10 million.
For other exceptions to the uniform capitalization rules, see
section 1.263A-1(b) of the regulations.
For information on the special rules that apply to costs incurred
in the business of farming, see chapter 7 of Publication 225,
Farmer's Tax Guide.
Intangible Assets
Intangible assets include goodwill, patents, copyrights,
trademarks, trade names, and franchises. The basis of an intangible
asset is usually the cost to buy or create it. If you acquire multiple
assets, for example a going business for a lump sum, see
Allocating the Basis, later, to figure the basis of the
individual assets. The basis of certain intangibles can be amortized.
See chapter 9 of Publication 535
for information on the amortization
of these costs.
Patents.
The basis of a patent you get for your invention is the cost of
development, such as research and experimental expenditures, drawings,
working models, and attorneys' and governmental fees. If you deduct
the research and experimental expenditures as current business
expenses, you cannot include them in the basis of the patent. The
value of the inventor's time spent on an invention is not part of the
basis.
Copyrights.
If you are an author, the basis of a copyright will usually be the
cost of getting the copyright plus copyright fees, attorneys' fees,
clerical assistance, and the cost of plates that remain in your
possession. Do not include the value of your time as the author, or
any other person's time you did not pay for.
Franchises, trademarks, and trade names.
If you buy a franchise, trademark, or trade name, the basis is its
cost, unless you can deduct your payments as a business expense.
Allocating the Basis
If you buy multiple assets for a lump sum, allocate the amount you
pay among the assets you receive. Make this allocation to figure your
basis for depreciation and gain or loss on a later disposition of any
of these assets. See Trade or Business Acquired, later.
Group of Assets Acquired
If you buy multiple assets for a lump sum, you and the seller may
agree to a specific allocation of the purchase price among the assets
in the sales contract. If this allocation is based on the value of
each asset and you and the seller have adverse tax interests, the
allocation generally will be accepted. However, see Trade or
Business Acquired, next.
Trade or Business Acquired
If you acquire a trade or business, allocate the purchase price to
the various assets acquired.
For asset acquisitions occurring after January 5, 2000,
the allocation must be made among the following assets in
proportion to (but not more than) their fair market value on the
purchase date in the following order.
- Certificates of deposit, U.S. Government securities, foreign
currency, and actively traded personal property, including stock and
securities.
- Accounts receivable, mortgages, and credit card receivables
that arose in the ordinary course of business.
- Property of a kind that would properly be included in
inventory if on hand at the end of the tax year and property held by
the taxpayer primarily for sale to customers in the ordinary course of
business.
- All other assets except section 197 intangibles, goodwill,
and going concern value.
- Section 197 intangibles except goodwill and going concern
value.
- Goodwill and going concern value (whether or not they
qualify as section 197 intangibles).
For asset acquisitions occurring before January 6, 2000,
the allocation must be made among the following assets in
proportion to (but not more than) their fair market value on the
purchase date in the following order.
- Certificates of deposit, U.S. Government securities, foreign
currency, and actively traded personal property, including stock and
securities.
- Accounts receivable, mortgages, and credit card receivables
that arose in the ordinary course of business.
- Property of a kind that would properly be included in
inventory if on hand at the end of the tax year and property held by
the taxpayer primarily for sale to customers in the ordinary course of
business.
- All other assets except section 197 intangibles, goodwill,
and going concern value.
- Section 197 intangibles except goodwill and going concern
value.
- Section 197 intangibles in the nature of goodwill and going
concern value.
Agreement.
The buyer and seller may enter into a written agreement as to the
allocation of any consideration or the FMV of any of the assets. This
agreement is binding on both parties unless the IRS determines the
amounts are not appropriate.
Reporting requirement.
Both the buyer and seller involved in the sale of business assets
must report to the IRS the allocation of the sales price among section
197 intangibles and the other business assets. Use Form 8594
to provide this information. The buyer and seller should each attach
Form 8594 to their federal income tax return for the year in which the
sale occurred.
More information.
See Sale of a Business in chapter 2 of Publication 544
for more information.
Land and Buildings
If you buy buildings and the land on which they stand for a lump
sum, allocate the basis of the property among the land and the
buildings so you can figure the depreciation allowable on the
buildings.
Figure the basis of each asset by multiplying the lump sum by a
fraction. The numerator is the FMV of that asset and the denominator
is the FMV of the whole property at the time of purchase. If you are
not certain of the FMV of the land and buildings, you can allocate the
basis based on their assessed values for real estate tax purposes.
Demolition of building.
Add demolition costs, and other losses incurred for the demolition
of any building, to the basis of the land on which the demolished
building was located. Do not claim the costs as a current deduction.
Modification of building.
A modification of a building will not be treated as a demolition if
the following conditions are satisfied.
- 75 percent or more of the existing external walls of the
building are retained in place as internal or external walls.
- 75 percent or more of the existing internal structural
framework of the building is retained in place.
If the building is a certified historic structure the
modification must also be part of a certified rehabilitation.
If these conditions are met, add the costs of the modifications to
the basis of the building.
Subdivided lots.
If you buy a tract of land and subdivide it, you must determine the
basis of each lot. This is necessary because you must figure the gain
or loss on the sale of each individual lot. As a result, you do not
recover the entire cost in the tract until you have sold all of the
lots.
To determine the basis of an individual lot, multiply the total
cost of the tract by a fraction. The numerator is the FMV of the lot
and the denominator is the FMV of the entire tract.
Future improvement costs.
If you are a developer and sell subdivided lots before the
development work is completed, you can (with IRS consent) include, in
the basis of the properties sold, an allocation of the estimated
future cost for common improvements. See Revenue Procedure 92-29
for more information, including an explanation of the procedures for
getting consent from the IRS.
Use of erroneous cost basis.
If you made a mistake in figuring the cost basis of subdivided lots
sold in previous years, you cannot correct the mistake for years for
which the statute of limitations has expired. Figure the basis of any
remaining lots by allocating the correct original cost basis of the
entire tract among the original lots.
Example.
You bought a tract of land to which you assigned a cost of $15,000.
You subdivided the land into 15 building lots of equal size and
equitably divided your basis so that each lot had a basis of $1,000.
You treated the sale of each lot as a separate transaction and figured
gain or loss separately on each sale.
Several years later you determine that your original basis in the
tract was $22,500 and not $15,000. You sold eight lots using $8,000 of
basis in years for which the statute of limitations has expired. You
now can take $1,500 of basis into account for figuring gain or loss
only on the sale of each of the remaining seven lots ($22,500 basis
divided among all 15 lots). You cannot refigure the basis of the eight
lots sold in tax years barred by the statute of limitations.
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