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If you have your own business, if you have investments, or you sold your home or other personal assets, you know the importance of cost basis for tax purposes.
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Basis is generally the amount of your capital investment in a property. You use the cost basis to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange or other disposition of the property.
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Here are some basic notions on cost basis.
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In most situations, the basis of a property you buy is its cost. The cost is the amount you pay for it in cash, debt obligations, and other property or services.
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It is important to note that the cost basis is focused on how much the holder of the asset had to pay in order to complete the acquisition, not the actual value of the asset itself.
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Your cost may also includes amounts you pay for the following items:
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- Installation and testing,
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- Legal and accounting fees (when they must be capitalized),
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- Real estate taxes (if assumed for the seller).
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You might also have to capitalize (add to basis) certain other costs related to buying or producing property.
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If you have investments, 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 (for instance if inherited), your basis is usually determined by the fair market value (FMV) or the previous owner's adjusted basis of the stock.
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| If you buy real property, certain fees and other expenses become part of your cost basis in the property. |
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| Your basis includes the settlement fees and closing costs for buying property. You cannot include in your basis the fees and costs for getting a loan on property. |
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| The following items are some of the settlement fees or closing costs you can include in the basis of your property. |
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- Abstract fees (abstract of title fees);
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- Charges for installing utility services;
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- Legal fees (including title search and preparation of the sales contract and deed);
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- Owner's title insurance; and
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- 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.
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| If you build property or have assets built for you, your expenses for this construction are part of your basis. |
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If you purchase property to use in your business, your basis is usually its actual cost to you.
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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, which specify the costs you add to basis in certain circumstances.
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As for intangible assets (which may include goodwill, patents, copyrights, trademarks, trade names, and franchises) the basis is usually the cost to buy or create it.
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Before figuring gain or loss on a sale, exchange, or other disposition of property, or before figuring allowable depreciation, you must determine the adjusted basis of that property. Certain events that occur during your period of ownership may increase or decrease your basis, resulting in an "adjusted basis."
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You can increase your basis by items such as the cost of improvements that add to the value of the property, and decrease it by items such as depreciation allowable and insurance reimbursements for casualty and theft losses.
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Generally, when you sell, exchange or otherwise dispose of a capital asset, you report it on Form 1040, Schedule D. However, there are changes to the reporting requirements for returns filed for the 2012 tax year. Many transactions that previously would have been reported on Schedule D or D-1 must be reported on Form 8949 if they occurred in 2012.
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| Starting in tax year 2011, brokers must report the adjusted basis and whether any gain or loss on a sale is classified as short-term or long-term from the sale of "covered securities" on Form 1099-B. "Covered securities" are generally shares of corporate stock acquired on or after January 1, 2011. |
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| Shares of stock in mutual funds and stock acquired in connection with a dividend reinvestment plan are generally not covered unless acquired after January 1, 2012. |
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Certain other types of securities (e.g., debt instruments and options) will be covered if acquired after January 1, 2014.
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Beginning in tax year 2011, Form 8949 replaces Schedule D-1. Details for individual transactions pertaining to short-term and long-term dispositions are reported on Form 8949, and then entered on the Schedule D.
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While the cost basis is most commonly associated with the acquisition price of the asset, there are exceptions. One notable exception is when real estate or other holdings are acquired as an inheritance. Since no actual purchase was made, the cost basis in this case is usually the appraisal value of the assets at the time of the benefactor’s death. However, the exact regulations governing the calculation of a cost basis may vary somewhat according to circumstances and the laws in place locally.
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For this reason (and not only), it is always a good idea to consult a tax advisor if there are extenuating circumstances associated with the acquisition.
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