Basis (Tax)

What is Basis (Tax)?

Basis (Tax) is a fundamental taxation concept referring to the starting value of an asset for tax purposes. This starting value is crucial for calculating gains or losses when the asset is sold, as well as for determining allowable depreciation deductions.

Key Points

Original Cost: Basis generally reflects the asset’s original purchase price.
Gains and Losses: An asset’s basis is critical for computing taxable gains or losses upon its sale.
Depreciation: Basis determines the allowable depreciation deductions on an asset.
Adjustments: Basis can be adjusted upwards or downwards based on additional investments (capital improvements) or other factors.

Examples

Example 1: Property Purchase

Collins purchases land for $100,000 and erects a store for $800,000. Her tax basis in the property is $900,000. If she sells the property for $950,000, she realizes a $50,000 gain ($950,000 - $900,000).

Example 2: Depreciation Calculations

In the same scenario, if Collins claims depreciation on the property, the $800,000 cost basis of the improvements is depreciable. However, the $100,000 basis allocated to the land is not depreciable, as land does not suffer wear and tear over time.

Frequently Asked Questions (FAQs)

What is the significance of Basis (Tax) in real estate?

Basis (Tax) acts as the starting value for an asset and is crucial in determining taxable outcomes when the asset is sold or depreciated.

How is the initial basis of a property determined?

The initial basis is typically the purchase price of the property plus any additional costs incurred to acquire the asset, such as closing costs and inspection fees.

Can the basis of a property change?

Yes, the basis can be adjusted. Additions, improvements, and certain legal fees can increase the basis, while depreciation, insurance reimbursements, and certain tax deductions can decrease it.

Does basis include mortgage amounts?

No, the basis itself does not include the amount of any mortgage. However, the cost of acquiring or improving the property, even if financed through a mortgage, adds to the basis.

What is an adjusted basis?

The adjusted basis is the initial basis of a property, adjusted upwards or downwards by certain events such as improvements, depreciation, and damage recoveries.

Adjusted Tax Basis

Defined as the original basis plus or minus any adjustments like improvements or depreciation.

Depreciation

An income tax deduction that allows for the recovery of the cost of an income-producing property over time, reflecting wear and tear.

Capital Gains

The profit realized from the sale of an asset over the original purchase price, calculated using the asset’s tax basis.

Capital Improvements

Costs of increasing the value or extending the life of the property, which can be added to the basis.

Online Resources

IRS Publication 551: Basis of Assets - Comprehensive guidance on determining and adjusting basis.
IRS Topic No. 703, Basis of Assets - Information from the IRS regarding the basis of assets.

References

U.S. Internal Revenue Service. “Publication 551: Basis of Assets.” Accessed [insert date].
U.S. Internal Revenue Service. “Topic No. 703, Basis of Assets.” Accessed [insert date].

Suggested Books for Further Study

“Real Estate Taxation: A Practitioner’s Guide” by David F. Windish
“Tax-Free Wealth: How to Build Massive Wealth by Permanently Lowering Your Taxes” by Tom Wheelwright
“The Book on Tax Strategies for the Savvy Real Estate Investor” by Amanda Han and Matthew MacFarland

Real Estate Basics: Basis (Tax) Fundamentals Quiz

### Which of the following items is included in the basis of a property? - [ ] Mortgage amount - [x] Purchase price - [ ] Loan interest - [ ] Monthly rent received > **Explanation:** The purchase price is included in the basis of the property. Costs such as mortgage amounts and loan interest do not directly affect the basis. ### When Collins purchased land and erected a store, what was her initial tax basis in the property? - [ ] $100,000 - [ ] $800,000 - [x] $900,000 - [ ] $1,000,000 > **Explanation:** Collins' tax basis in the property was the sum of the land purchase price and the cost of erecting the store, totaling $900,000. ### How does depreciation affect the basis of a property? - [x] It decreases the basis over time - [ ] It does not affect the basis - [ ] It increases the basis over time - [ ] It neutralizes the basis > **Explanation:** Depreciation decreases the basis of a property over time, reflecting the annual tax deductions allowed for wear and tear. ### Can land undergo depreciation for tax purposes? - [ ] Yes, land can always be depreciated. - [ ] Land can be depreciated if it produces income. - [x] No, land cannot be depreciated. - [ ] Land can be depreciated only when used for residential purposes. > **Explanation:** Land cannot be depreciated, regardless of its use, as it does not wear out or lose value due to usage. ### What is the significance of adjusted tax basis? - [ ] It includes only the initial purchase price. - [x] It is the basis after accounting for additions and subtractions like improvements and depreciation. - [ ] It disregards any depreciation claims. - [ ] It varies depending on asset type without external influence. > **Explanation:** The adjusted tax basis is the originally established basis, modified by permitted additions (e.g., improvements) and subtractions (e.g., depreciation). ### In which scenario is an adjusted tax basis essential? - [x] When calculating capital gains or losses on the sale of property. - [ ] When purchasing property. - [ ] During monthly rent collections. - [ ] At property appraisal intervals. > **Explanation:** Adjusted tax basis is crucial when determining capital gains or losses upon the sale of the property. ### What happens to the basis when significant capital improvements are made to a property? - [ ] The basis decreases. - [x] The basis increases. - [ ] The basis remains the same. - [ ] The basis is recalculated from scratch. > **Explanation:** Significant capital improvements increase the basis as these contribute additional value to the property. ### What is not considered in increasing the basis of a piece of property? - [ ] The cost of initial construction - [ ] Major home improvements - [x] Monthly utility expenses - [ ] The initial purchase price > **Explanation:** Monthly utility expenses do not increase the basis; only costs directly adding to or improving the property do. ### What tax deduction only affects the structure and not the land on which it stands? - [ ] Landscaping - [x] Depreciation - [ ] Property taxes - [ ] Building fees > **Explanation:** Depreciation deductions affect the structure only, as they account for the wear and tear and usage of the building but do not apply to land. ### When selling property, how does one determine a gain or loss for tax purposes? - [x] By subtracting the adjusted tax basis from the selling price - [ ] By comparing mortgage balance to the selling price - [ ] By checking improvements added solely - [ ] By evaluating property’s fair market value only > **Explanation:** A gain or loss for tax purposes is determined by subtracting the adjusted tax basis from the property's selling price.