Tax basis is the cost or value of an asset – used to determine equity or ownership for the purpose of tax assessment, exchange, or sale. It generally includes purchase price, taxes, transportation costs, and fees, and is increased or decreased based on what occurs to the property during its owner’s period of ownership in order to determine the owner’s adjusted basis. Basis creates a way for deciding what part of a sale of property or a business should be taxed. When the property is sold, the entity selling the property is only taxed for any amount of the sale that is above the basis. For example, if ABC Co. had a tax basis of $1,000,000 for a building and sold the building for $1,200,000, ABC Co. would only be taxed on $200,000 ($1,200,000-$1,000,000=$200,000).
When the assigned value of a property is based solely on its cost of acquisition, its basis is referred to as cost basis – which is generally the case for most assets. The cost of acquisition may include amounts that are paid by cash, debt obligations, and other property or services.
In the case of common assets, like stocks and bonds, the basis is generally the purchase price, plus additional costs such as commissions and recording or transfer fees. However, there are cases where the basis of an asset is not determined by the taxpayer’s cost of acquisition, but rather by an asset’s fair market value or the basis of a previous owner.
Some activities will change the basis of property for a variety of reasons such as increased costs or property depreciation. Changing the tax basis more accurately reflects what the owner should be taxed on after sale. For example, Katie bought a business for $5,000,000 which depreciated in value by $1,000,000, and Katie used depreciation on her taxes for the next ten years effectively avoiding taxes on $1,000,000. In order to account for this, Katie’s cost basis would be lowered to $4,000,000. This means that once the property is sold, Katie will incur taxes for anything over $4,000,000 instead of $5,000,000.
Examples of expenses that increase basis include:
- Rehabilitation expenses
- The cost of extending utility service lines to a property
- Impact fees
- Legal fees for defending and perfecting title
- Zoning costs
Examples of expenses that decrease basis include:
- Deductions for clean-fuel vehicles and refueling property
- Deductions for amortization, depreciation, and depletion
- Postponed gain from the sale of a home
- Casualty and theft losses and insurance reimbursements
- Cancelled debt that is excluded from income
- Rebates from a manufacturer or seller
[Last updated in October of 2021 by the Wex Definitions Team]