Contributed by: CoryF, FreeTaxUSA Agent, Tax Pro
You just purchased a new business asset. How do you figure how much it cost and what to put as its basis for tax purposes? Pulling value estimates out of the air is risky, so it is best to use receipts and calculations to build the cost basis of your new asset.
Cost Basis Starting Point
The best method to use is established guidelines from the IRS to figure costs and value. For details see IRS Publication 551, Basis of Assets. The initial value is the most important starting point. This can be as simple as how much you paid for the asset or can get complicated when bigger purchases, like buildings, have hidden costs that are added to the cost basis. Figuring out the cost basis when purchasing a business or partnership in a business can even be more complex. Remember, each time a part or material is added to an asset, its cost basis increases.
Any asset that is purchased from a store or dealership has a cost basis already built in as the amount you paid to purchase it. For example, furniture, computers, software, and cars have a simple method for the value that is translated into the cost basis. In addition to using your hard-earned cash, you may use a loan to purchase an asset. The value of the principal (main amount of the loan) plus the interest over the life of the loan is the cost of the item purchased with a loan. This includes sale tax if that is part of the purchase price. So, the money, loan, interest, and/or sales tax sum up to the cost basis of these types of assets.
Buildings, Homes and Improvements
The next type of asset is the purchase of a home, building, or investment land. This can be confusing since there are other costs to consider on top of the purchase price, like loan closing costs. The value of the land and building (home) has an initial value/price that is considered, but when the actual purchase is made, closing costs are added. Here are some common closing costs that add to the cost basis of a building/home:
- Legal fees
- Recording fees
- Surveys
- Transfer taxes
- Title Insurance
In addition to the purchase of land and buildings, you may want to repair or add structures like walls, roofing, or air conditioning units at some point. The cost of the units plus the improvement costs adds directly to the cost basis of the building/home. Generally, any costs associated with basic repairs like painting walls or simple maintenance are expenses not associated with the cost basis of the building and are deducted from your taxes each year.
Assets Received by Gift or Inheritance
Although gifted or inherited assets do not cost you any money, the IRS has a defined cost basis for assets like this. When someone gives you a gift, the cost basis of that item to you is the same cost basis of the person who gave it to you. When you inherit an asset from a family member, the cost basis is the fair market value of that item on the day the family member passed away.
For example, your grandma gave you a piece of art that she bought in the 1960’s for a couple of hundred dollars. Your cost basis in the art is the 200 dollars she originally paid. However, if instead of receiving the painting as a gift, you inherit the piece of art after your grandmother's passing, the rules are a little different. Your cost basis is the fair market value on the date she passes away, which could be thousands since fine art generally appreciates in value.
Just remember, cost basis almost always starts with the price that is paid for an asset. Any money paid to make an asset better or bigger is something you add to the cost basis. Business assets almost always have tax implications, while your personal assets (your stuff) can mostly be ignored when you are filing your tax return.
Now you have the correct cost basis for your assets, you’re ready to move onto depreciation.
