For tax purposes, the sale of property typically triggers a gain or loss. The gain or loss realized on the sale of property is calculated by subtracting the basis of the property sold from the proceeds received on the sale. Most basis calculations are simple, but they can be quite complicated depending on the transaction. Basis is calculated differently depending on how the property being sold was initially acquired. In general, property is most commonly acquired in the three following ways:
Property Acquired by Purchase
The simplest to calculate, the basis of property acquired by purchase is the original capital investment, or cost, to the taxpayer. Additional adjustments may be necessary depending on the type of property acquired.
Example 1: A house that will be used for rental purposes was purchased on June 1, 2015 for $200,000; it was determined that $50,000 of the purchase price should be allocated to land and $150,000 should be allocated to improvements. A new porch was installed (just in time for fall weather) on September 1, 2015, costing $10,000. On May 15, 2016, the house was sold for $250,000. Assuming $8,500 of depreciation, what basis should be used in calculating the gain on the sale of the property?
Beginning (Cost) Basis $200,000
Adj: Porch 10,000
Less: Depreciation (on improvements) (8,500) Adjusted Basis at 5/15/2016 $201,500
Example 2: 1,159 shares of Coca Cola stock were purchased on December 7, 2015 for $50,000. On April 20, 2016, dividends of $200 were paid to and reinvested by the taxpayer. What is basis in the Coca Cola stock?
Beginning (Cost) Basis $50,000
Adj: Dividends Reinvested 200
Adjusted Basis at 4/20/2016 $50,200
Property Acquired by Gift
The basis of property acquired by gift is generally the same as it would be in the hands of the donor – known as a carryover basis. However, if the sale of the property acquired by gift results in a loss, the basis is the lesser of the adjusted basis of the property prior to the date of the gift or the fair market value (FMV) of the property at the time of the gift.
Example: Assume the above 1,159 shares of Coca Cola stock were gifted to the taxpayer’s son on April 21, 2016. At this time, the stock’s FMV is $45,000. The taxpayer’s adjusted basis in the stock was $50,200 prior to the date of the gift, so this basis would “carryover” to the son on the gifting of the shares. However, if the son later sold the shares for $40,000, the basis used in calculating the loss would be $45,000 as opposed to $50,200, since that amount is the lesser of the carryover basis ($50,200) and the FMV at the date of the gift ($45,000).
Property Acquired by Exchange
The basis of property acquired in an exchange where no gain or loss is recognized is the same as the property exchanged –known as a substitute basis. Common examples of substitute basis transactions include like-kind exchanges and stock exchanges for the stock of the same corporation. Property exchanges that qualify for nonrecognition treatment are complex and specific calculations are beyond the scope of this article.
It is important to understand general basis concepts and how your basis impacts any gain or loss realized on the sale of property. For more information on basis-related concerns, please contact your Bennett Thrasher tax advisor by calling 770.396.2200.