5.20 How To Find Adjusted Basis

After determining the unadjusted cost basis for property (5.16–5.19), you may have to increase it or decrease it to find your adjusted basis, which is the amount used to figure your gain or loss on a sale (5.13).

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image Court Decision
Improvements Covered by Note
In an unusual case, the owner of office condominiums financed substantial improvements to the units by giving promissory notes to a contracting company that he controlled. Before paying off the notes he sold the units. He included the cost of the improvements in basis to figure his gain on the sale, but the IRS, with the approval of a federal district court, held that this was improper. The court held that as a cash-basis taxpayer, he could not include the face amount of the notes in the basis of the condominiums until the notes were paid.
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1. Additions to basis. You add to unadjusted basis the cost of these items:
  • All permanent improvements and additions to the property and other capital costs. Increase basis for capital improvements such as adding a room or a fence, putting in new plumbing or wiring, and paving a driveway. Also include capital costs such as the cost of extending utility service lines, assessments for local improvements such as streets, sidewalks, or water connections, and repairing your property after a casualty (for example, repair costs after a fire or storm).
  • Legal fees. Increase basis by legal fees incurred for defending or perfecting title, or for obtaining a reduction of an assessment levied against property to pay for local benefits.
  • Sale of unharvested land. If you sell land with unharvested crops, add the cost of producing the crops to the basis of the property sold.
2. Decreases to basis. You reduce cost basis for these items:
  • Return of capital, such as dividends on stock paid out of capital or out of a depletion reserve when the company has no available earnings or surplus (4.11).
  • Losses from casualties and thefts, including insurance awards and payments in settlement of damages to your property, and deductible casualty/theft losses not covered by insurance.
  • Depletion allowances (9.15).
  • Depreciation, first-year expensing deduction, ACRS deductions, amortization, and obsolescence on property used in business or for the production of income. In some years, you may have taken more or less depreciation than was allowable.
If you claim less than what was allowable, you must deduct from basis the allowable amount rather than what was actually claimed. You may be able to file an amended return to claim the full allowable depreciation for a year. If IRS rules do not allow the correction on an amended return, you can change your accounting method in order to claim the correct amount of depreciation; see IRS Publication 946 for details.
If you took more depreciation than was allowable, you may have to make the following adjustments: If you have deducted more than what was allowable and you received a tax benefit from the deduction, you deduct from basis the full amount of the depreciation. But if the excess depreciation did not give you a tax benefit, because income was eliminated by other deductions, the excess is not deducted from basis.
  • Amortized bond premium (4.17).
  • Cancelled debt excluded from income. If you did not pay tax on certain cancellations of debt because of bankruptcy or insolvency, or on qualifying farm debt or business real property, you reduce basis of your property for the amount forgiven (11.8).
  • Investment credit. Where the full investment credit was claimed in 1983 or later years, basis is reduced by one-half the credit.
EXAMPLE
Your vacation home, which cost $75,000, is damaged by fire. You deducted the uninsured loss of $10,000 and spent $11,000 to repair the property. Several years later, you sell the house for $90,000. To figure your profit, increase the original cost of the house by the $11,000 of repairs and then reduce basis by the $10,000 casualty loss to get an adjusted basis of $76,000 ($75,000 + $11,000 − $10,000). Your gain on the sale is $14,000 ($90,000 − $76,000).
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