Determining Basis
For federal income taxation purposes, determining basis depends on how the asset in question was acquired.
Assets acquired by purchase or contract: For assets purchased or acquired contractually, the basis equals the purchase price. See IRC (Internal Revenue Code) § 1012.
Assets acquired by gift or trust: The general rule is that assets acquired by gift or trust receive transferred basis (also called carryover basis). See IRC § 1015. Put simply, gifted assets retain the donor's basis. This means that the value of the asset at the time of transfer is irrelevant to computing the donee's new basis. The general rule does not apply, however, if at the time of transfer the donor's adjusted basis in the property exceeds its fair market value and the recipient disposes of the property at a loss. In this situation the asset's basis is its fair market value at the time of transfer. See Treas. Reg. § 1.1015-1(a)(1).
Assets acquired by inheritance: Assets acquired by inheritance are eligible to receive stepped-up basis, meaning the fair market value of the asset at the time of the decedent's death. See IRC § 1014. This provision shields the appreciation in value of the asset during the life of the decedent from any income taxation whatsoever.
Adjusted basis: An asset's basis can increase or decrease depending on changes that occur throughout its lifetime. For this reason, IRC § 1001(a) provides that computing gain requires determining the amount realized from the sale or disposition of property minus the adjusted basis. Capital improvements (such as adding a deck to your house) increase the asset's basis while depreciation deductions (statutory deductions that reduce the taxpayer's taxable income for a given year) diminish the asset's basis. Another way of viewing adjusted basis is to think of the asset as a savings account, with capital improvements representing deposits and depreciation deductions representing withdrawals.
Read more about this topic: Cost Basis
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