Basis of Property is very crucial as one navigates through tax problems and issues. In some instances the basis will be the amount that will be subject to depreciation. People usually think of basis as the cost of an asset. In many instances it is. In others it is not. For example, if you buy a house and use it as a rental property, for the purpose of depreciation the cost of the house is not the basis of depreciation.
What Is My Cost for Depreciation Basis?
Also, if you buy a business as asset purchase the basis of the machinery in the business is not the original cost of the machinery. Rather it may be your cost allocated on whatever machineries there are. An example to illustrate the point is the following. Suppose you bought a business that has only two copiers. The original owners bought the two copiers for five thousand dollars each. Suppose you paid ninety thousand in an asset purchase.
You have the right to allocate the ninety thousand to the only two machines there are in that business. Each machine will start with a basis of forty five thousand dollars as its new basis. When you depreciate the machines you depreciate the forty five thousand dollars not the five thousand dollars. You can see the difference in the amount of depreciation that you can take and the impact on your tax bill.
Inherited Properties Are Not Valued Cost
Take another example of knowing the difference between the basis and the cost. John inherited a thousand stocks from his dad. Dad bought the stocks sixty years ago for five dollars a share at a total cost of five thousand dollars. Stocks at the date of death were worth one million dollars (a thousand dollars each).
The question is how much does he make if he turns around and sells the stock for one million and seven thousand dollars one month after he inherits the money? The answer is seven thousand dollars. He made only seven thousand dollars that will be subject to tax. How come? Because he has a totally new basis that’s different from the amount of the cost of the stock his Dad paid. Dad’s cost was five thousand dollars. John’s basis (say new cost) is one million dollars and thus his profit will be seven thousand dollars. This is due to a rule called step up in basis in case of inheritance.
So if you don’t know the law and you are one of those do-it yourself type, you may be hurting yourself big time by either paying too much tax or incurring tax debt that may not be needed. The best way to avoid these tax problems is to find tax help through professionals such as CPAs or tax attorneys especially if you find yourself navigating in deep water, when a lot of money may be at stake.
Dean Alexander is the CEO of NFA Tax Help and has been helping clients with tax issues for over 35 years. More information is available at www.resolvemytaxes.com.