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Determine Initial
Basis of Property

Learn how the IRS determines the starting value of property for tax purposes: from purchases, gifts, and inheritances.

CPA Regulation (REG)

What Is Basis?

In tax law, basis is the amount of your investment in property for tax purposes. It is used to calculate gain or loss when you sell or dispose of property, and to figure depreciation and other deductions.

Why Basis Matters

Property
Basis: \(\$100,000\)
Sale Price
\(\$150,000\)
Gain
\(\$50,000\)
\( \text{Gain} = \text{Amount Realized} - \text{Adjusted Basis} \)
\( \$50,000 = \$150,000 - \$100,000 \)

Three Ways to Acquire Property

Purchase
You buy the property in an arm's-length transaction: basis = cost.
Gift
Property received as a gift: basis generally = donor's adjusted basis (carryover).
Inheritance
Property received from a decedent: basis = fair market value at date of death (stepped-up).

Cost Basis: The Purchase Rule

When you purchase property, your initial basis equals the total cost of acquiring it. This includes more than just the purchase price.

1
Purchase price: The amount paid to the seller.
2
Sales tax: Any sales or excise taxes paid on acquisition.
3
Settlement costs: Legal fees, title insurance, recording fees, surveys.
4
Freight and installation: Costs to get the asset ready for its intended use.

Gift Basis: Carryover Rule

When you receive property as a gift, the basis depends on the relationship between the donor's adjusted basis and the fair market value (FMV) at the date of the gift.

1
If \( \text{FMV} > \text{donor's basis} \) (gain property): your basis = donor's adjusted basis (carryover basis).
2
If \( \text{FMV} < \text{donor's basis} \) (loss property): your basis depends on whether you sell at a gain or loss.
3
Gift tax paid by the donor may increase the donee's basis (the appreciation portion).

The Double Basis Rule

When \( \text{FMV at Gift Date} < \text{Donor's Basis} \)
Donor's Basis
FMV at Gift
Sell Above Donor's Basis
Use: Donor's Basis
No Man's Land
No Gain, No Loss
Sell Below FMV
Use: FMV at Gift Date
For Gain: use Donor's Basis
For Loss: use FMV at Gift Date

Inherited Basis: Stepped-Up Rule

Property received from a decedent (through inheritance) generally receives a basis equal to the fair market value (FMV) at the date of death. This is called a "stepped-up" (or stepped-down) basis.

Step Up
If \( \text{FMV at death} > \text{decedent's basis} \), the heir gets a higher basis: all unrealized gain is forgiven.
Step Down
If \( \text{FMV at death} < \text{decedent's basis} \), the heir gets a lower basis: the unrealized loss disappears.

Gift vs. Inheritance

Gift Inheritance
Basis Rule Carryover (donor's basis) Stepped-up to FMV
Holding Period Includes donor's period (tacks on) Always long-term
Loss Property Double basis rule applies Stepped-down (loss vanishes)
Unrealized Gain Transfers to donee Forgiven at death
Tax Impact Donor may owe gift tax Included in estate tax

How to Determine Initial Basis

1
Identify how property was acquired: Purchase, gift, inheritance, or exchange?
2
Purchase: Sum up total cost including taxes, fees, and installation.
3
Gift: Compare donor's basis to FMV at the gift date. Apply carryover or double-basis rule.
4
Inheritance: Use FMV at date of death (or alternate valuation date).
5
Check for adjustments: Gift tax paid, improvements, or partial interests may alter basis.

Example 1: Purchase Basis

1
Purchase price: \(\$25,000\)
2
+ Sales tax: \(\$1,500\)
3
+ Delivery: \(\$800\)
4
+ Installation: \(\$1,200\)

Example 2: Gift Basis

Since \( \text{FMV} (\$55,000) > \text{donor's basis} (\$40,000) \), this is gain property. Tyler uses the carryover basis.

Example 3: Double Basis Gift

1
\( \text{FMV} (\$60,000) < \text{Donor's basis} (\$80,000) \): double basis rule applies.
2
For gain, use donor's basis \(\$80,000\). Sale \( \$70,000 < \$80,000 \): no gain.
3
For loss, use FMV \(\$60,000\). Sale \( \$70,000 > \$60,000 \): no loss.
4
Sale price falls in the "no man's land": no gain or loss recognized.

Example 4: Inherited Basis

Inherited property receives a stepped-up basis to FMV at the date of death.

Common Mistakes

✕ Using FMV for Gifts
Students use FMV as gift basis when \( \text{FMV} > \text{donor's basis} \). The correct rule is carryover (donor's basis) for gain property.
✕ Ignoring Double Basis
When \( \text{FMV} < \text{donor's basis} \), students forget to check both bases. The sale price may fall in the "no man's land" zone.
✕ Forgetting Closing Costs
For purchases, basis includes all acquisition costs: taxes, legal fees, freight, and installation, not just the purchase price.

Summary: Initial Basis Rules

Acquisition Basis Rule Key Detail
Purchase Cost (total acquisition cost) Include taxes, fees, installation
Gift (\( \text{FMV} > \text{basis} \)) Donor's adjusted basis Carryover basis; tack holding period
Gift (\( \text{FMV} < \text{basis} \)) Double basis rule Gain: donor's basis; Loss: FMV
Inheritance FMV at date of death Stepped-up or stepped-down; always LT
Inheritance (alt.) FMV 6 months after death Only if it reduces estate value + tax

Question 1 of 5

Sam purchases a building for \(\$200,000\), pays \(\$3,000\) in legal fees and \(\$2,000\) in recording fees. What is Sam's initial basis in the building?

Question 2 of 5

Donna gives her nephew stock with an adjusted basis of \(\$30,000\) and a FMV of \(\$45,000\) at the date of gift. No gift tax was paid. What is the nephew's basis for determining gain?

Question 3 of 5

Tom inherits land from his mother. Her adjusted basis was \(\$50,000\). The FMV at the date of death was \(\$120,000\). What is Tom's basis in the land?

Question 4 of 5

Karen receives land as a gift. The donor's basis was \(\$100,000\) and the FMV at the date of the gift was \(\$70,000\). Karen sells the land for \(\$85,000\). What is Karen's recognized gain or loss?

Question 5 of 5

Which of the following statements about inherited property is correct?