There are many times when you cannot use cost as a basis. In these cases, the fair market value or the adjusted basis of certain property may be used. Fair market value and adjusted basis were discussed earlier.

Taxable Exchanges

A taxable exchange is one in which the gain is taxable or the loss is deductible. If you get property in exchange for other property in a taxable exchange, the basis of the property you receive is usually its FMV at the time of the exchange.

Property Received for Services

If you receive property for your services, the property's FMV is taxable. The taxable amount becomes your basis. If the services were performed for a price agreed on beforehand, the price will be accepted as the FMV of the property if there is no evidence to the contrary.

Restricted property. If you receive property, such as stock, for your services and the property is subject to certain restrictions, your basis in the property is its FMV when it becomes substantially vested, unless you make an election to include the value of the property in income the year it is transferred to you. Property becomes substantially vested when it is not subject to a substantial risk of forfeiture. For more information, see Restricted Property Received for Services in Publication 525.

Bargain purchases. A bargain purchase is a purchase of an item for less than its FMV. If, as compensation for services, someone you work for lets you buy goods or other property at less than FMV, include the difference between the purchase price and the property's FMV in your income. Your basis in the property is its FMV (your purchase price plus the amount you include in income).

If the difference between your purchase price and the FMV is a qualified employee discount, do not include the difference in income. However, your basis in the property is still its FMV. See Qualified Employee Discount in chapter 4 of Publication 535.

Property Received as a Gift

To figure the basis of property you receive as a gift, you must know its adjusted basis to the donor just before it was given to you. You also must know its FMV at the time it was given to you and any gift tax paid on it.

FMV less than donor's adjusted basis. If the FMV of the property is less than the donor's adjusted basis, your basis for figuring gain on its sale or other disposition is the donor's adjusted basis plus or minus any required adjustment to basis while you held the property. Your basis for figuring loss on its sale or other disposition is its FMV when you got the gift plus or minus any required adjustment to basis while you held the property. See Adjusted Basis, earlier.

Example. You received an acre of land as a gift. At the time of the gift, the land had an FMV of $8,000. The donor's adjusted basis was $10,000. After you received the property, no events occurred to increase or decrease your basis in it. If you later sell the property for $12,000, you will have a $2,000 gain. You must use the donor's adjusted basis ($10,000) at the time of the gift as your basis to report a gain. If you sell the property for $7,000, you have a $1,000 loss because you must use the FMV ($8,000) at the time of the gift to report a loss.

If the sales price were between $8,000 and $10,000, you would have neither a gain nor a loss.

Business property. If you hold the gift as business property, your basis for figuring any depreciation, depletion, or amortization deduction is the same as the donor's adjusted basis plus or minus any required adjustments to basis while you hold the property.

FMV equal to or greater than donor's adjusted basis. If the FMV of the property is equal to or greater than the donor's adjusted basis, your basis for figuring gain or loss on its sale or other disposition is the same as the donor's adjusted basis at the time you got the gift. Increase your basis by all or part of any gift tax paid, depending on the date of the gift.

Also, for figuring gain or loss from a sale or other disposition or for figuring depreciation, depletion, or amortization deductions on business property, you must increase or decrease your basis (the donor's adjusted basis) for any required adjustments to basis while you held the property. See Adjusted Basis, earlier.

Gift received before 1977. If you received a gift before 1977 on which gift tax was paid, increase your basis in the gift by the amount of the gift tax. However, do not increase your basis above the FMV of the gift at the time it was given to you.

Gift received after 1976. If you received a gift after 1976 on which gift tax was paid, increase your basis in the gift by the part of the gift tax due to the net increase in value of the gift. Figure the increase by multiplying the gift tax paid by a fraction. The numerator of the fraction is the net increase in value of the gift and the denominator is the value of the gift. The net increase in value of the gift is the FMV of the gift minus the donor's adjusted basis.

Example. Last year you received a gift of property from your mother that had an FMV of $50,000. Her adjusted basis was $20,000. She paid a gift tax of $9,000 on the property. For figuring depreciation, depletion, amortization, and gain or loss, your basis is $25,400, figured as follows:

Fair market value	$50,000
Minus: Adjusted basis	20,000
Net increase in value	$30,000
Gift tax paid	$9,000
Multiplied by ($30,000 � $50,000)	�.60
Gift tax due to net increase in value	$5,400
Plus: Adjusted basis of property to
your mother	20,000
Your basis in the property	$25,400

Inherited Property

If a federal estate tax return has to be filed, your basis in property you inherit is usually its fair market value (FMV) at the date of the decedent's death. It can also be the FMV at an alternate valuation date if the estate qualifies and elects to use alternate valuation. If a federal estate tax return does not have to be filed, your basis in the inherited property is its appraised value at the date of death for state inheritance or transmission taxes.

Your basis in inherited property may also be figured under the special farm or closely held business real property valuation method, if chosen for estate tax purposes.

For more information about the basis of inherited property, see Inherited Property in Publication 551.

Property Changed to Business or Rental Use

When you hold property for personal use and change it to business use or use it to produce rent, you must figure its basis for depreciation. An example of changing property held for personal use to business use would be renting out your former main home.

Basis for depreciation. The basis for depreciation is the lesser of either of the following amounts.

1. The FMV (defined earlier under Cost Basis) of the property on the date of the change.
2. Your adjusted basis (defined earlier under Adjusted Basis) on the date of the change.

Example. Several years ago, you paid $160,000 to have your house built on a lot that cost you $20,000. Before changing the property to rental use last year, you paid $20,000 for permanent improvements to the house and claimed a $2,000 casualty loss deduction to the house. Because land is not depreciable, you can include only the cost of the house when figuring the basis for depreciation.

Your adjusted basis in the house when you changed its use was $178,000 ($160,000 + $20,000 - $2,000).

On the date of the change in use, your property had an FMV of $180,000, of which $15,000 was for the land and $165,000 was for the house. The basis for figuring depreciation on the house is the FMV on the date of the change ($165,000) because it is less than your adjusted basis ($178,000).

Sale of property. If you later sell or dispose of the property, the basis you use will depend on whether you are figuring gain or loss.

Gain. Your basis for figuring a gain is your adjusted basis (not the basis for depreciation) when you sell the property.

Example. Assume the same facts as the previous example except that you sell the property after being allowed depreciation deductions of $37,500. Your basis for figuring gain would be $160,500 ($178,000 + $20,000 (land) - $37,500).

Loss. Figure the basis for a loss starting with the smaller of your adjusted basis or the FMV of the property at the time of the change.

Example. Assume the same facts as the previous example. Your basis for figuring loss in this case would be the FMV ($180,000) because it is less than the adjusted basis of $198,000 ($178,000 + $20,000 (land)) on the date of the change. That amount ($180,000) is reduced by the depreciation deduction to arrive at a basis of $142,500 ($180,000 - $37,500).

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