Basis in the World of Tax: Property, Part 1

Calculating basis of property can be complex, so I’ve broken it into three pieces. In this article, I’ll cover basis of converted property, property acquired incident to divorce and property acquired by gift.

Converted Property

Basis of depreciation of property that is converted from personal to business use is the lesser of:

  • the adjusted basis on the date of conversion, or
  • the fair market value at the time of conversion, plus the costs of any improvements, less any deductions claimed for casualty and theft losses or other items that reduce basis.

Please note that basis for the sale of converted property at a gain is cost basis.

If sold at a loss, basis is the lower of:

  • the cost, or
  • the fair market value on the date of conversion

If sold to a related party at a loss, the loss is not deductible, but it reduces the gain realized when the related party eventually sells the property. It does not increase depreciable basis.

Property Acquired Incident to Divorce

No gain or loss is recognized on transfers between spouses at any time, even if the transfer is in exchange for cash or other consideration.

Basis in the property is the same as the former spouse’s basis; the holding period begins at the time the former spouse acquired the property.

For example, Russell and Kari bought a house for $250,000 and made no improvements to the property. After owning the home for five years, they divorce. The fair market value at the time of the divorce is $300,000. The divorce decree states that Kari keeps the house but has to pay $50,000 to Russell to buy him out. Her basis is still $250,000; the $50,000 that she paid to Russell does not increase her basis. Russell does not have to pay tax on the money either because it was a transfer incident to divorce.

Property Acquired by Gift

Tax basis of property received by a U.S. person as a gift is the same as the donor’s tax basis in the property. If the fair market value of the property exceeds this tax basis and the donor pays gift tax, the tax basis is increased by the amount of the gift tax. This adjustment applies only if the recipient sells the property at a gain.

Basis of property received as a gift is generally the same as the basis of the preceding owner who did not acquire the property by gift. However, upon the sale of gifted property at a loss, the basis is the lower of the adjusted basis or the fair market value at the time of the gift. Sometimes, there is no gain or loss because the selling price is less than the basis for gain and more than the basis for loss.

The holding period for the recipient includes the donor’s holding period.

Here are some examples:

  • Russell’s uncle gifts him an acre of land with a fair market value of $5,000 at the time of the gift. The uncle’s adjusted basis was $10,000. Russell later sells the property for $15,000. Russell realizes a $5,000 gain because he must use his uncle’s basis as his basis.
  • Same facts as above, except that Russell sells the property for $4,000. In this case, he has a $1,000 loss because he now must use the fair market value at the time of the gift of $5,000, which creates a lower loss than using carryover basis.
  • If the property is sold for an amount between $5,000 and $10,000, then there is no loss or gain. In this case, the basis for a loss would be $5,000 fair market value and the basis for gain would be $10,000 carryover basis. One results in a gain, and the other results in a loss; therefore, neither the gain nor the loss is recognized.

Basis of property is a complex topic, and we’re not quite done. Stay tuned to the Intuit® ProConnect™ Tax Pro Center for the next articles in my series on basis and more on property basis.

Source: Basis in the World of Tax: Property, Part 1, Tax Pro Center

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