Before a taxpayer can figure out the gain or loss on the sale, exchange, or other disposition of property or figuring allowance depreciation, depletion, or amortization, a taxpayer must usually make certain adjustments to the cost of the property. Once these adjustments are made, the amount remaining is the adjusted basis.
Below is a list of the specific items that can increase or decrease the basis of property for gain or loss calculations.
Items that Increase Basis
You can increase the basis of a property by all items properly added to a capital account. Usually this includes two items, capital improvements and assessments for local improvements.
Capital improvements can be thought of as costs of improvements having a useful life of more than one year, which increase the value of property, lengthen its life, or adapt it to a different use. These include:
1. Paving a driveway
2. Building a fence
3. Installing new plumbing or wiring within the house
4. Adding a new roof
5. Adding an additional bathroom and/or bedroom
Assessments for local improvements can be thought of as property assessments for improvements that increase the value of the property. It is important to not deduct these assessments as taxes. They will include:
3. Extending utility service to the property
4. Water connections
Remember that both of these types of circumstances will increase the basis of the property for calculating gain or loss.
Items that Increase Basis
The next step is to decrease the basis of any property by all items that represent a return of capital for the period during which the taxpayer held the property. Examples of items that decrease basis include:
1. Non taxable corporate distributions – These dividends reflect a return of capital and reduces basis.
2. Casualty and theft losses – Decrease the basis of property by any insurance proceeds or other reimbursements and by any deductible loss not covered by insurance. Also remember that you can increase the basis for amounts that were spent on repairs to restore the property to its pre casualty condition.
3. Depreciation and Section 179 deduction – The basis of a taxpayer’s qualifying business property will be decreased by any section 179 deductions taken and the depreciation deducted. This also includes depreciation that could have been deducted but was not.
4. Easements – The IRS will consider compensation for granting an easement proceeds from the sale of an interest in real property.
5. Credits – Basis may be reduced by the amount of credits received for the alternative motor vehicle credit, alternative fuel vehicle refueling property credit, and the residential energy efficient property credit.
Remember that this is just a general outline of the most common items that will decrease basis and therefore other situations can also cause the reduction of basis.