Understanding Basis in Business Assets

Understanding Basis in Business Assets

– Surgent Exam Review Video

Welcome to this section on business assets. This session will focus on the key concept of basis.

  • Basis is generally the cost of property — including payments in cash, debt obligations, property, or services.
  • It may include additional costs that must be capitalized, not expensed immediately.
  • Basis affects:
    • Depreciation deductions
    • Gain or loss on sale or disposal
    • Tax treatment in exchanges and special transactions

Topics Covered

  • Basis of stocks and bonds
  • Business property like equipment and buildings
  • Asset bundles and basis allocation
  • Conversion of personal to business use
  • Non-taxable exchanges (e.g., 1031 like-kind)

Stocks and Bonds

  • Basis = Purchase Price + Additional Costs (broker commissions, transfer fees, etc.)
  • Example: 100 shares @ $10 + $50 commission → Basis = $1,050
  • Gain/Loss = Sale Price – Adjusted Basis

Purchased Business Property

  • Basis includes purchase price plus capitalized costs:
    • Sales tax
    • Freight
    • Installation/testing
    • Excise tax
    • Settlement/closing costs for real estate
  • Example: $10,000 equipment + $1,000 additional costs → Basis = $11,000

Real Estate Settlement Costs

  • Capitalized Costs:
    • Abstract fees
    • Utility installation charges
    • Legal/title search fees
    • Recording and survey fees
    • Owner’s title insurance
  • Example: $200,000 property + $5,000 in costs → Basis = $205,000

Repairs vs. Improvements

  • Improvements increase basis; they:
    • Extend useful life
    • Increase productivity
    • Adapt the asset for a new use
  • Repairs do not increase basis; typically deductible as current expenses.

Basis Decreases Over Time

  • Common reduction: Depreciation
  • Other basis reductions:
    • Energy conservation subsidies
    • Casualty/theft loss deductions
    • Insurance reimbursements
    • Electric vehicle and Section 179 deductions
    • Non-taxable corporate distributions

Bundled Asset Purchases

  • Use residual method to allocate purchase price:
    1. CDs, US securities, foreign currency, actively traded assets
    2. Accounts receivable and similar items
    3. Inventory or resale items
    4. All other tangible business property
    5. Section 197 intangibles (customer lists, trademarks)
    6. Goodwill and going-concern value
  • Each asset’s allocated value becomes its starting basis

Personal to Business Use Conversions

  • Basis for depreciation = lesser of:
    • Fair market value at date of conversion
    • Adjusted basis at that time
  • Prevents depreciation claims on personal-use losses
  • Sale calculation:
    • Gain: use original basis
    • Loss: use lower of FMV or adjusted basis

Non-Taxable Exchanges (Section 1031)

  • No gain/loss recognized; basis carries over
  • Example: $50K basis → exchanged for $80K property → new basis = $50K
  • Rules:
    • Only applies to real property post-2017
    • Held for business or investment, not resale
    • Can be done multiple times
    • “Like-kind” doesn’t mean identical (e.g., land for building)
    • U.S. property cannot be exchanged for foreign property

Final Notes

  • Track basis carefully for each asset
  • Adjust basis for improvements and reductions properly
  • Good records ensure correct depreciation, gains/losses, and tax reporting