Adjusted Basis

Before figuring gain or loss on a sale, exchange, or other disposition of property or figuring allowable depreciation, depletion, or amortization, you must usually make certain adjustments to the basis of the property. The result of these adjustments is the adjusted basis of the property.

Increases to Basis

Increase the basis of any property by all items properly added to a capital account. These include the cost of improvements having a useful life of more than 1 year.

The following costs increase the basis of property.

• Extending utility service lines to property.
• Legal fees, such as the cost of defending and perfecting title.
• Legal fees for obtaining a decrease in an assessment levied against property to pay for local improvements.

If you make additions or improvements to business property, keep separate accounts for them. Depreciate the basis of each addition or improvement according to the depreciation rules that would apply to the underlying property if you had placed it in service at the same time you placed the addition or improvement in service. See chapter 8.

Assessments for local improvements.   Increase the basis of property by assessments for items such as paving roads and building ditches that increase the value of the property assessed. Do not deduct them as taxes. However, you can deduct as taxes charges for maintenance, repairs, or interest charges related to the improvements.

Deducting vs. capitalizing costs.   Do not add to your basis costs you can deduct as current expenses. For example, amounts paid for incidental repairs or maintenance are deductible as business expenses and are not added to basis. However, you can choose either to deduct or to capitalize certain other costs. See chapter 8 in Publication 535.

Decreases to Basis

The following items reduce the basis of property.

• The section 179 deduction.
• The deduction for clean-fuel vehicles and clean-fuel vehicle refueling property.
• Investment credit (part or all) taken.
• Casualty and theft losses and insurance reimbursements.
• Amounts you receive for granting an easement.
• Deductions previously allowed or allowable for amortization, depreciation, and depletion.
• Special depreciation allowance on qualified property.
• Exclusion from income of subsidies for energy conservation measures.
• Credit for qualified electric vehicles.
• Certain canceled debt excluded from income.
• Rebates.
• Patronage dividends received as a result of a purchase of property. See Patronage Dividends in chapter 4.
• Gas-guzzler tax.
• Employer-provided child care credit.

Some of these items are discussed next.

Section 179 deduction.   If you take the section 179 deduction for all or part of the cost of qualifying business property, decrease the basis of the property by the deduction. For more information, see Section 179 Deduction in chapter 8.

Deduction for clean-fuel vehicle and clean-fuel vehicle refueling property.   If you take the deduction for clean-fuel vehicles or clean-fuel vehicle refueling property, decrease the basis of the property by the deduction. For more information, see chapter 12 in Publication 535.

Casualties and thefts.   If you have a casualty or theft loss, decrease the basis of the property by the amount of any insurance or other reimbursement. Also, decrease it by any deductible loss not covered by insurance. See chapter 13 for information about figuring your casualty or theft loss.

You must increase your basis in the property by the amount you spend on repairs that substantially prolong the life of the property, increase its value, or adapt it to a different use. To make this determination, compare the repaired property to the property before the casualty.

Easements.   The amount you receive for granting an easement is usually considered to be from the sale of an interest in the real property. It reduces the basis of the affected part of the property. If the amount received is more than the basis of the part of the property affected by the easement, reduce your basis in that part to zero and treat the excess as a recognized gain. See Easements and rights-of-way in chapter 4.

Depreciation.   Decrease the basis of property by the depreciation you deducted, or could have deducted, on your tax returns under the method of depreciation you chose. If you took less depreciation than you could have or you did not take a depreciation deduction, reduce the basis by the full amount of depreciation you could have taken. If you deducted more depreciation than you should have, decrease your basis by the amount you should have deducted plus the part of the excess depreciation you deducted that actually reduced your tax liability for any year.

See chapter 8 for information on figuring the depreciation you should have claimed. See also Changing Your Accounting Method in chapter 8 for information that may benefit you if you deducted the wrong amount of depreciation.

In decreasing your basis for depreciation, take into account the amount deducted on your tax returns as depreciation and any depreciation you must capitalize under the uniform capitalization rules.

Special depreciation allowance.   Decrease the basis of property by the special depreciation allowance on qualified property. Do not decrease the basis if you made the election not to claim the special depreciation allowance. See chapter 8 for more information on the special depreciation allowance.

Exclusion from income of subsidies for energy conservation measures.   You can exclude from gross income any subsidy you received from a public utility company for the purchase or installation of an energy conservation measure for a dwelling unit. Reduce the basis of the property by the excluded amount.

Credit for qualified electric vehicle.   If you claim the credit for a qualified electric vehicle, you must reduce your basis in that vehicle by the lesser of the following amounts.

• $4,000.
• 10% of the vehicle's cost.

This reduction amount applies even if the credit allowed is less than that amount. For more information on this credit, see chapter 12 in Publication 535.

Canceled debt excluded from income.   If a debt you owe is canceled or forgiven, other than as a gift or bequest, you generally must include the canceled amount in your gross income for tax purposes. A debt includes any indebtedness for which you are liable or which attaches to property you hold.

You can exclude your canceled debt from income if the debt is included in any of the following categories.

1. Debt canceled in a bankruptcy case or when you are insolvent.
2. Qualified farm debt.
3. Qualified real property business debt (provided you are not a C corporation).

If you exclude canceled debt described in (1) or (2), you may have to reduce the basis of your depreciable and nondepreciable property. If you exclude canceled debt described in (3), you must reduce the basis of your depreciable property by the excluded amount.

For more information about canceled debt in a bankruptcy case, see Publication 908, Bankruptcy Tax Guide. For more information about insolvency and canceled debt that is qualified farm debt, see chapter 4. For more information about qualified real property business debt, see chapter 5 in Publication 334, Tax Guide for Small Business.

Employer-provided child care credit.   If you claim the employer-provided child care credit for amounts paid or incurred to acquire, construct, rehabilitate, or expand property used as part of your qualified child care facility, you must reduce your basis in the property by the amount of the credit. For information on the credit, see Form 8882, Credit for Employer-Provided Child Care Facilities and Services.

Basis Other Than Cost

There are times when you cannot use cost as basis. In these situations, the fair market value or the adjusted basis of property may be used. Adjusted basis was discussed earlier. Fair market value is discussed next.

Fair market value (FMV).   Fair market value (FMV) is the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts. Sales of similar property on or about the same date may help in figuring the FMV of the property.

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 from personal to business use would be renting out your personal residence.

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

• The FMV of the property on the date of the change.
• Your adjusted basis on the date of the change.

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

Example.   George Smith is an accountant and also operates a farming business. George agreed to do some accounting work for his neighbor in exchange for a dairy cow. The accounting work and the cow are each worth $1,500. George must include $1,500 in income for his accounting services. George's basis in the cow is $1,500.

Taxable Exchanges

A taxable exchange is one in which the gain is taxable, or the loss is deductible. A taxable gain or deductible loss also is known as a recognized gain or loss. A taxable exchange occurs when you receive cash or get property that is not similar or related in use to the property exchanged. If you receive 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.

Example.   You trade a tract of farm land with an adjusted basis of $3,000 for a tractor that has an FMV of $6,000. You must report a taxable gain of $3,000 for the land. The tractor has a basis of $6,000.

Nontaxable Exchanges

A nontaxable exchange is an exchange in which you are not taxed on any gain and you cannot deduct any loss. A nontaxable gain or loss also is known as an unrecognized gain or loss. If you receive property in a nontaxable exchange, its basis is usually the same as the basis of the property you transferred.

Example.   You traded a truck you used in your farming business for a new smaller truck to use in farming. The adjusted basis of the old truck was $10,000. The FMV of the new truck is $14,000. Because this is a nontaxable exchange, you do not recognize any gain, and your basis in the new truck is $10,000, the same as the adjusted basis of the truck you traded.

Like-Kind Exchanges

The exchange of property for the same kind of property is the most common type of nontaxable exchange.

For an exchange to qualify as a like-kind exchange, you must hold for business or investment purposes both the property you transfer and the property you receive. There must also be an exchange of like-kind property. For more information, see Like-Kind Exchanges in chapter 10.

The basis of the property you receive is the same as the basis of the property you gave up.

Example.   You trade a machine (adjusted basis $8,000) for another like-kind machine (FMV $9,000). You use both machines in your farming business. The basis of the machine you receive is $8,000, the same as the machine traded.

Exchange expenses.   Exchange expenses generally are the closing costs that you pay. They include such items as brokerage commissions, attorney fees, and deed preparation fees. Add them to the basis of the like-kind property you receive.

Property plus cash.   If you trade property in a like-kind exchange and also pay money, the basis of the property you receive is the basis of the property you gave up plus the money you paid.

Example.   You trade in a truck (adjusted basis $3,000) for another truck (FMV $7,500) and pay $4,000. Your basis in the new truck is $7,000 (the $3,000 basis of the old truck plus the $4,000 cash).

Special rules for related persons.   If a like-kind exchange takes place directly or indirectly between related persons and either party disposes of the property within 2 years after the exchange, the exchange no longer qualifies for like-kind exchange treatment. Each person must report any gain or loss not recognized on the original exchange. Each person reports it on the tax return filed for the year in which the later disposition occurred. If this rule applies, the basis of the property received in the original exchange will be its FMV. For more information, see chapter 10.

Exchange of business property.   Exchanging the property of one business for the property of another business is a multiple property exchange. For information on figuring basis, see Multiple Property Exchanges in chapter 1 of Publication 544.

Partially Nontaxable Exchange

A partially nontaxable exchange is an exchange in which you receive unlike property or money in addition to like property. The basis of the property you receive is the same as the basis of the property you gave up with the following adjustments.

1. Decrease the basis by the following amounts.
   1. Any money you receive.
   2. Any loss you recognize on the exchange.
2. Increase the basis by the following amounts.
   1. Any additional costs you incur.
   2. Any gain you recognize on the exchange.

If the other party to the exchange assumes your liabilities, treat the debt assumption as money you received in the exchange.

Example 1.   You trade farm land (basis $10,000) for another tract of farm land (FMV $11,000) and $3,000 cash. You realize a gain of $4,000. This is the FMV of the land received plus the cash minus the basis of the land you traded ($11,000 + $3,000 - $10,000). Include your gain in income (recognize gain) only to the extent of the cash received. Your basis in the land you received is figured as follows.

Basis of land traded	$10,000
Minus: Cash received (adjustment 1(a))	- 3,000
	$7,000
Plus: Gain recognized (adjustment 2(b))	+ 3,000
Basis of land received	$10,000

Example 2.   You trade a truck (adjusted basis $22,750) for another truck (FMV $20,000) and $10,000 cash. You realize a gain of $7,250. This is the FMV of the truck received plus the cash minus the adjusted basis of the truck you traded ($20,000 + $10,000 - $22,750). You include all the gain in your income (recognize gain) because the gain is less than the cash you received. Your basis in the truck you received is figured as follows.

Adjusted basis of truck traded	$22,750
Minus: Cash received (adjustment 1(a))	- 10,000
	$12,750
Plus: Gain recognized (adjustment 2(b))	+ 7,250
Basis of truck received	$20,000

Allocation of basis.   If you receive like and unlike properties in the exchange, allocate the basis first to the unlike property, other than money, up to its FMV on the date of the exchange. The rest is the basis of the like property.

Example.   You had an adjusted basis of $15,000 in a tractor you traded for another tractor that had an FMV of $12,500. You also received $1,000 cash and a truck that had an FMV of $3,000. The truck is unlike property. You realized a gain of $1,500. This is the FMV of the tractor received plus the FMV of the truck received plus the cash minus the adjusted basis of the tractor you traded ($12,500 + $3,000 + $1,000 - $15,000). You include in income (recognize) all $1,500 of the gain because it is less than the FMV of the unlike property plus the cash received. Your basis in the properties you received is figured as follows.

Adjusted basis of old tractor	$15,000
Minus: Cash received (adjustment 1(a))	- 1,000
	$14,000
Plus: Gain recognized (adjustment 2(b))	+ 1,500
Total basis of properties received	$15,500

basis of the tractor.

Sale and Purchase

If you sell property and buy similar property in two mutually dependent transactions, you may have to treat the sale and purchase as a single nontaxable exchange.

Example.   You used a tractor on your farm for 3 years. Its adjusted basis is $2,000 and its FMV is $4,000. You are interested in a new tractor, which sells for $15,500. Ordinarily, you would trade your old tractor for the new one and pay the dealer $11,500. Your basis for depreciation for the new tractor would then be $13,500 ($11,500 + $2,000, the basis of your old tractor). However, you want a higher basis for depreciating the new tractor, so you agree to pay the dealer $15,500 for the new tractor if he will pay you $4,000 for your old tractor. Because the two transactions are dependent on each other, you are treated as having exchanged your old tractor for the new one and paid $11,500 ($15,500 - $4,000). Your basis for depreciating the new tractor is $13,500, the same as if you traded the old tractor.

Involuntary Conversions

If you receive property as a result of an involuntary conversion, such as a casualty, theft, or condemnation, you may figure the basis of the replacement property you receive using the basis of the converted property.

Similar or related property.   If the replacement property is similar or related in service or use to the converted property, the replacement property's basis is the same as the old property's basis on the date of the conversion. However, make the following adjustments.

1. Decrease the basis by the following amounts.
   1. Any loss you recognize on the involuntary conversion.
   2. Any money you receive that you do not spend on similar property.
2. Increase the basis by the following amounts.
   1. Any gain you recognize on the involuntary conversion.
   2. Any cost of acquiring the replacement property.

Money or property not similar or related.   If you receive money or property not similar or related in service or use to the converted property and you buy replacement property similar or related in service or use to the converted property, the basis of the replacement property is its cost decreased by the gain not recognized on the involuntary conversion.

For more information about involuntary conversions, see chapter 13.

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