What Is IRS Publication 551: Basis of Assets?

IRS Publication 551, “Basis of Assets,” explains how to determine your investment in a property for tax purposes, an amount known as the “basis.” This value is the starting point for calculating the gain or loss when you sell or dispose of property. Keeping accurate records to track an asset’s basis is necessary to support your tax calculations.

Determining Original Basis

The method used to acquire an asset determines its initial basis. For property you purchase, the basis is its cost. This “cost basis” includes the purchase price plus expenses to complete the purchase, such as sales tax, freight charges, and installation fees. For real estate, this also includes settlement fees and closing costs, like legal fees, recording fees, and abstract fees.

When you inherit property, the basis is the fair market value (FMV) of the property on the date of the owner’s death. This is referred to as a “stepped-up” or “stepped-down” basis, as it adjusts to the current market value, which can erase taxable gain accumulated by the previous owner. An alternative valuation date, six months after the date of death, can be elected by the estate’s executor if certain conditions are met.

For property received as a gift, the recipient takes on the donor’s adjusted basis at the time of the gift, which is a “carryover basis.” This means the recipient is also responsible for tax on any appreciation during the donor’s ownership. However, a special rule applies if the property’s FMV is less than the donor’s adjusted basis at the time of the gift. If you later sell this property for a loss, your basis for calculating that loss is the lower FMV.

Adjustments to Basis

The basis of your property is not a static figure and changes over time, resulting in an “adjusted basis.” The adjusted basis is calculated by taking the original basis and accounting for events that either increase or decrease it.

Certain expenditures on your property will increase your basis. The most common increase comes from capital improvements, which add to the property’s value, prolong its useful life, or adapt it to new uses. Examples include adding a room, installing a new central air system, or paving a driveway. These are distinct from routine repairs and maintenance, which are not added to the basis. Assessments for local improvements, like new public sidewalks, also increase your basis.

Conversely, other events will decrease your basis. For property used for business or to produce income, you must take depreciation deductions, which reduce your basis each year. Receiving an insurance reimbursement for a casualty or theft loss decreases your basis by the amount of the payment. Certain tax credits, such as for energy-efficient home improvements, can also require a reduction in the property’s basis.

Calculating Gain or Loss

When you sell or dispose of property, you must calculate your gain or loss for tax purposes. This calculation uses the adjusted basis you have tracked. The formula is your amount realized minus your adjusted basis, which equals your taxable gain or loss.

The “amount realized” is the total value you receive for the property, including cash and the fair market value of any other property or services. The amount realized is reduced by selling expenses you incur, such as real estate commissions, advertising fees, or legal fees. These costs lower your overall gain.

For example, you purchased a home for $250,000, your original basis. You spent $30,000 on a kitchen remodel, a capital improvement, increasing your adjusted basis to $280,000 ($250,000 + $30,000). You later sell the home for $350,000 and pay a $20,000 real estate commission, making your amount realized $330,000 ($350,000 – $20,000). The taxable gain is $50,000 ($330,000 – $280,000).