Basis of Investment Property Words you may need to know (see Glossary): Basis Fair market value Original issue discount (OID) Basis is a way of measuring your investment in property for taxpurposes. You must know the basis of your property to determinewhether you have a gain or loss on its sale or other disposition. Investment property you buy normally has an original basis equal toits cost. If you get property in some way other than buying it, suchas by gift or inheritance, its fair market value may be important infiguring the basis. Cost Basis The basis of property you buy is usually its cost. The cost is theamount you pay in cash, debt obligations, or other property orservices. Unstated interest.If you buy property under a deferred-payment plan that chargeslittle or no interest, you may have to treat part of the purchaseprice as interest. You must subtract this amount, if any, from yourcost to find your basis. For more information, see UnstatedInterest in Publication 537. Basis Other Than Cost There are times when you must use a basis other than cost. In thesecases, the fair market value or the adjusted basis of certain propertymay be used. Fair market value.This is the price at which the property would change hands betweena buyer and a seller, neither being forced to buy or sell and bothhaving reasonable knowledge of all the relevant facts. Sales ofsimilar property, around the same date, may be helpful in figuringfair market value. Property Received for Services If you receive investment property for services, you must includethe property's fair market value in income. The amount you include inincome then becomes your basis in the property. If the services wereperformed for a price that was agreed to beforehand, this price willbe accepted as the fair market value of the property if there is noevidence to the contrary. Restricted property.If you receive, as payment for services, property that is subjectto certain restrictions, your basis in the property generally is itsfair market value when it becomes substantially vested. Propertybecomes substantially vested when it is transferable or is no longersubject to substantial risk of forfeiture, whichever happens first.See Restricted Property in Publication 525 for moreinformation. Bargain purchases.If you buy investment property at less than fair market value, aspayment for services, you must include the difference in income. Yourbasis in the property is the price you pay plus the amount you includein income. Property Receivedin Taxable Trades If you received investment property in trade for other property,the basis of the new property is its fair market value at the time ofthe trade unless you received the property in a nontaxable trade. Example.You trade A Company stock for B Company stock having a fair marketvalue of $1,200. If the adjusted basis of the A Company stock is lessthan $1,200, you have a taxable gain on the trade. If the adjustedbasis of the A company stock is more than $1,200, you have adeductible loss on the trade. The basis of your B Company stock is$1,200. If you later sell the B Company stock for $1,300, you willhave a gain of $100. Property Receivedin Nontaxable Trades If you have a nontaxable trade, you do not recognize gain or lossuntil you dispose of the property you received in the trade. SeeNontaxable Trades, later. The basis of property you received in a nontaxable or partlynontaxable trade is generally the same as the adjusted basis of theproperty you gave up. Increase this amount by any cash you paid,additional costs you had, and any gain recognized. Reduce this amountby any cash or unlike property you received, any loss recognized, anyliability of yours that was assumed or treated as assumed. Property ReceivedFrom Your Spouse If property is transferred to you from your spouse (or formerspouse, if the transfer is incident to your divorce), your basis isthe same as your spouse's or former spouse's adjusted basis justbefore the transfer. See Transfers Between Spouses, later. Files: Recordkeeping.The transferor must give youthe records necessary to determine the adjusted basis and holdingperiod of the property as of the date of the transfer. Property Received as a Gift To figure your basis in property that you received as a gift, youmust know its adjusted basis to the donor just before it was given toyou, its fair market value at the time it was given to you, the amountof any gift tax paid on it, and the date it was given to you. Fair market value less than donor's adjusted basis.If the fair market value of the property at the time of the giftwas less than the donor's adjusted basis just before the gift, yourbasis for gain on its sale or other disposition is the sameas the donor's adjusted basis plus or minus any required adjustmentsto basis during the period you hold the property. Your basis forloss is its fair market value at the time of the gift plusor minus any required adjustments to basis during the period you holdthe property. No gain or loss.If you use the basis for figuring a gain and the result is a loss,and then use the basis for figuring a loss and the result is a gain,you will have neither a gain nor a loss. Example.You receive a gift of investment property having an adjusted basisof $10,000 at the time of the gift. The fair market value at the timeof the gift is $9,000. You later sell the property for $9,500. Youhave neither gain nor loss. Your basis for figuring gain is $10,000,and $10,000 minus $9,500 results in a $500 loss. Your basis forfiguring loss is $9,000, and $9,500 minus $9,000 results in a $500gain. Fair market value equal to or more than donor's adjustedbasis.If the fair market value of the property at the time of the giftwas equal to or more than the donor's adjusted basis just before thegift, your basis for gain or loss on its sale or otherdisposition is the donor's adjusted basis plus or minus any requiredadjustments to basis during the period you hold the property. Also,you may be allowed to add to the donor's adjusted basis all or part ofany gift tax paid, depending on the date of the gift. Gift received before 1977.If you received property as a gift before 1977, your basis in theproperty is the donor's adjusted basis increased by the total gift taxpaid on the gift. However, your basis cannot be more than the fairmarket value of the gift at the time it was given to you. Example 1.You were given XYZ Company stock in 1976. At the time of the gift,the stock had a fair market value of $21,000. The donor's adjustedbasis was $20,000. The donor paid a gift tax of $500 on the gift. Yourbasis for gain or loss is $20,500, the donor's adjusted basis plus theamount of gift tax paid. Example 2.The facts are the same as in Example 1 except that the gift taxpaid was $1,500. Your basis is $21,000, the donor's adjusted basisplus the gift tax paid, but limited to the fair market value of thestock at the time of the gift. Gift received after 1976.If you received property as a gift after 1976, your basis is thedonor's adjusted basis increased by the part of the gift tax paid thatwas for the net increase in value of the gift. You figure this part bymultiplying the gift tax paid on the gift by a fraction. The numerator(top part) is the net increase in value of the gift and thedenominator (bottom part) is the amount of the gift. The net increase in value of the gift is the fair market value ofthe gift minus the donor's adjusted basis. The amount of the gift isits value for gift tax purposes after reduction by any annualexclusion and marital or charitable deduction that applies to thegift. Example.In 2000, you received a gift of property from your mother. At thetime of the gift, the property had a fair market value of $100,000 andan adjusted basis to her of $40,000. The amount of the gift for gifttax purposes was $90,000 ($100,000 minus the $10,000 annualexclusion), and your mother paid a gift tax of $21,000. You figureyour basis in the following way: Fair market value $100,000 Minus: Adjusted basis    40,000 Net increase in value of gift   $60,000 Gift tax paid $21,000 Multiplied by .667 ($60,000 $90,000)      .667 Gift tax due to net increase in value $14,007 Plus: Adjusted basis of property to yourmother    40,000 Your basis in the property   $54,007 Part sale, part gift.If you get property in a transfer that is partly a sale and partlya gift, your basis is the larger of the amount you paid for theproperty or the transferor's adjusted basis in the property at thetime of the transfer. Add to that amount the amount of any gift taxpaid on the gift, as described in the preceding discussion. Forfiguring loss, your basis is limited to the property's fair marketvalue at the time of the transfer. Gift tax information.For information on gift tax, see Publication 950, Introductionto Estate and Gift Taxes. Inherited Property If you inherited property, your basis in that property generally isits fair market value (its appraised value on the federal estate taxreturn) on: The date of the decedent's death, or The later alternate valuation date if the estate qualifiesfor, and elects to use, alternate valuation. If no federal estate tax return was filed, use the appraisedvalue on the date of death for state inheritance or transmissiontaxes. Appreciated property you gave the decedent.Your basis in certain appreciated property that you inherited isthe decedent's adjusted basis in the property immediately before deathrather than its fair market value. This applies to appreciatedproperty that you or your spouse gave the decedent as a gift duringthe one-year period ending on the date of death. Appreciated propertyis any property whose fair market value on the day you gave it to thedecedent was more than its adjusted basis. More information.See Publication 551, Basis of Assets, for moreinformation on the basis of inherited property, including communityproperty, a joint tenancy or tenancy by the entirety, a qualifiedjoint interest, and a farm or business. Adjusted Basis Before you can figure any gain or loss on a sale, exchange, orother disposition of property or figure allowable depreciation,depletion, or amortization, you usually must make certain adjustments(increases and decreases) to the basis of the property. The result ofthese adjustments to the basis is the adjusted basis. Adjustments to the basis of stocks and bonds are explained in thefollowing discussion. For information about other adjustments tobasis, see Publication 551. Stocks and Bonds The basis of stocks or bonds you own generally is the purchaseprice plus the costs of purchase, such as commissions and recording ortransfer fees. If you acquired stock or bonds other than by purchase,your basis is usually determined by fair market value or the previousowner's adjusted basis as discussed earlier under Basis OtherThan Cost. The basis of stock must be adjusted for certain events that occurafter purchase. For example, if you receive more stock from nontaxablestock dividends or stock splits, you must reduce the basis of youroriginal stock. You must also reduce your basis when you receivenontaxable distributions, because these are a return of capital. Identifying stock or bonds sold.If you can adequately identify the shares of stock or the bonds yousold, their basis is the cost or other basis of the particular sharesof stock or bonds. Identification not possible.If you buy and sell securities at various times in varyingquantities and you cannot adequately identify the shares you sell, thebasis of the securities you sell is the basis of the securities youacquired first. Except for certain mutual fund shares, discussedlater, you cannot use the average price per share to figure gain orloss on the sale of the shares. Example.You bought 100 shares of stock of XYZ Corporation in 1986 for $10 ashare. In January 1987 you bought another 200 shares for $11 a share.In July 1987 you gave your son 50 shares. In December 1989 you bought100 shares for $9 a share. In April 2000 you sold 130 shares. Youcannot identify the shares you disposed of, so you must use the stockyou acquired first to figure the basis. The shares of stock you gaveyour son had a basis of $500 (50 $10). You figure the basis ofthe 130 shares of stock you sold in 2000 as follows: 50 shares (50 $10) balance of stockbought in 1986 $500 80 shares (80 $11) stock bought inJanuary 1987       880 Total basis of stock sold in 2000    $1,380 Adequate identification.You will make an adequate identification if you show thatcertificates representing shares of stock from a lot that you boughton a certain date or for a certain price were delivered to your brokeror other agent. Broker holds stock.If you have left the stock certificates with your broker or otheragent, you will make an adequate identification if you: Tell your broker or other agent the particular stock to besold or transferred at the time of the sale or transfer, and Receive a written confirmation of this from your broker orother agent within a reasonable time. Single stock certificate.If you bought stock in different lots at different times and youhold a single stock certificate for this stock, you will make anadequate identification if you: Tell your broker or other agent the particular stock to besold or transferred when you deliver the certificate to your broker orother agent, and Receive a written confirmation of this from your broker orother agent within a reasonable time. Stock identified this way is the stock sold or transferred evenif stock certificates from a different lot are delivered to the brokeror other agent. If you sell part of the stock represented by a single certificatedirectly to the buyer instead of through a broker, you will make anadequate identification if you keep a written record of the particularstock that you intend to sell. Bonds.These methods of identification also apply to bonds sold ortransferred. Stock in a mutual fund or REIT.The basis of stock in a regulated investment company (mutual fund)or a real estate investment trust (REIT) is generally figured in thesame way as the basis of other stock. Mutual fund load charges.Your cost basis in mutual fund stock often includes a sales fee,also known as a load charge. But, in certain cases, you cannot includethe entire amount of a load charge in your basis if the charge givesyou a reinvestment right. For more information, see Publication 564. Choosing average basis for mutual fund stock.You can choose to use the average basis of mutual fund stock if youacquired the stock at various times and prices and left it on depositin an account kept by a custodian or agent who acquires or redeems thestock. The methods you can use to figure average basis are explainedin Publication 564. Undistributed capital gains.If you had to include in your income any undistributed capitalgains of the mutual fund or REIT, increase your basis in the stock bythe difference between the amount you included and the amount of taxpaid for you by the fund or REIT. See Undistributed capital gainsof mutual funds and REITs under Capital Gain Distributionsin chapter 1. Automatic investment service.If you participate in an automatic investment service, your basisfor each share of stock, including fractional shares, bought by thebank or other agent is the purchase price plus a share of the broker'scommission. Dividend reinvestment plans.If you participate in a dividend reinvestment plan and receivestock from the corporation at a discount, your basis is the full fairmarket value of the stock on the dividend payment date. You mustinclude the amount of the discount in your income. Public utilities.If, before 1986, you excluded from income the value of stock youhad received under a qualified public utility reinvestment plan, yourbasis in that stock is zero. Stock dividends.Stock dividends are distributions made by a corporation of its ownstock. Generally, stock dividends are not taxable to you. However, seeDistributions of Stock and Stock Rights underNontaxable Distributions in chapter 1for some exceptions.If the stock dividends are not taxable, you must divide your basis forthe old stock between the old and new stock. New and old stock identical.If the new stock you received as a nontaxable dividend is identicalto the old stock on which the dividend was declared, divide theadjusted basis of the old stock by the number of shares of old and newstock. The result is your basis for each share of stock. Example 1.You owned one share of common stock that you bought for $45. Thecorporation distributed two new shares of common stock for each shareheld. You then had three shares of common stock. Your basis in eachshare is $15 ($45 3). Example 2.You owned two shares of common stock. You had bought one for $30and the other for $45. The corporation distributed two new shares ofcommon stock for each share held. You had six shares after thedistribution--three with a basis of $10 each ($30 3) andthree with a basis of $15 each ($45 3). New and old stock not identical.If the new stock you received as a nontaxable dividend is notidentical to the old stock on which it was declared, the basis of thenew stock is calculated differently. Divide the adjusted basis of theold stock between the old and the new stock in the ratio of the fairmarket value of each lot of stock to the total fair market value ofboth lots on the date of distribution of the new stock. Example.You bought a share of common stock for $100. Later, the corporationdistributed a share of preferred stock for each share of common stockheld. At the date of distribution, your common stock had a fair marketvalue of $150 and the preferred stock had a fair market value of $50.You figure the basis of the old and new stock by dividing your $100basis between them. The basis of your common stock is $75 ($150/$200 $100), and the basis of the new preferred stock is $25($50/$200 $100). Stock bought at various times.Figure the basis of stock dividends received on stock you bought atvarious times and at different prices by allocating to each lot ofstock the share of the stock dividends due to it. Stock splits.Figure the basis of stock splits in the same way as stock dividendsif identical stock is distributed on the stock held. Taxable stock dividends.If your stock dividend is taxable when you receive it, the basis ofyour new stock is its fair market value on the date of distribution.The basis of your old stock does not change. Stock rights.A stock right is a right to acquire a corporation's stock. It maybe exercised, it may be sold if it has a market value, or it mayexpire. Stock rights are rarely taxable when you receive them. SeeDistributions of Stock and Stock Rights underNontaxable Distributions in chapter 1. Taxable stock rights.If you receive stock rights that are taxable, the basis of therights is their fair market value at the time of distribution. Thebasis of the old stock does not change. Nontaxable stock rights.If you receive nontaxable stock rights and allow them to expire,they have no basis. If you exercise or sell the nontaxable stock rights and if, at thetime of distribution, the stock rights had a fair market value of 15%or more of the fair market value of the old stock, you must divide theadjusted basis of the old stock between the old stock and the stockrights. Use a ratio of the fair market value of each to the total fairmarket value of both at the time of distribution. If the fair market value of the stock rights was less than 15%,their basis is zero. However, you can choose to divide the basis ofthe old stock between the old stock and the stock rights. To make thechoice, attach a statement to your return for the year in which youreceived the rights, stating that you choose to divide the basis ofthe stock. Basis of new stock.If you exercise the stock rights, the basis of the new stock is itscost plus the basis of the stock rights exercised. Example.You own 100 shares of ABC Company stock, which cost you $22 pershare. The ABC Company gave you 10 nontaxable stock rights that wouldallow you to buy 10 more shares at $26 per share. At the time thestock rights were distributed, the stock had a market value of $30,not including the stock rights. Each stock right had a market value of$3. The market value of the stock rights was less than 15% of themarket value of the stock, but you chose to divide the basis of yourstock between the stock and the rights. You figure the basis of therights and the basis of the old stock as follows: 100 shares $22 = $2,200, basis of old stock 100 shares $30 = $3,000, market value of oldstock 10 rights $3 = $30, market value of rights ($3,000 $3,030) $2,200 = $2,178.22,new basis of old stock ($30 $3,030) $2,200 = $21.78, basis ofrights If you sell the rights, the basis for figuring gain or loss is$2.18 ($21.78 10) per right. If you exercise the rights, thebasis of the stock you acquire is the price you pay ($26) plus thebasis of the right exercised ($2.18), or $28.18 per share. Theremaining basis of the old stock is $21.78 per share. Investment property received in liquidation.In general, if you receive investment property as a distribution inpartial or complete liquidation of a corporation and if you recognizegain or loss when you acquire the property, your basis in the propertyis its fair market value at the time of the distribution. S corporation stock.You must increase your basis in stock of an Scorporation by your pro rata share of the following items. All income items of the S corporation, including tax-exemptincome, that are separately stated and passed through to you as ashareholder. The nonseparately stated income of the S corporation. The amount of the deduction for depletion (other than oiland gas depletion) that is more than the basis of the property beingdepleted. You must decrease your basis in stock of an Scorporation by your pro rata share of the following items. Distributions by the S corporation that were not included inyour income. All loss and deduction items of the S corporation that areseparately stated and passed through to you. Any nonseparately stated loss of the S corporation. Any expense of the S corporation that is not deductible infiguring its taxable income and not properly chargeable to a capitalaccount. The amount of your deduction for depletion of oil and gaswells to the extent the deduction is not more than your share of theadjusted basis of the wells. However, your basis in the stock cannot be reduced below zero. Specialized small business investment company stock orpartnership interest.If you bought this stock or interest as replacement property forpublicly traded securities you sold at a gain, you must reduce thebasis of the stock or interest by the amount of any postponed gain onthat sale. See Rollover of Gain From Publicly TradedSecurities, later. Qualified small business stock.If you bought this stock as replacement property for otherqualified small business stock you sold at a gain, you must reduce thebasis of this replacement stock by the amount of any postponed gain onthe earlier sale. See Gains on Qualified Small BusinessStock, later. Short sales.If you cannot deduct payments you make to a lender in lieu ofdividends on stock used in a short sale, the amount you pay to thelender is a capital expense, and you must add it to the basis of thestock used to close the short sale. See Short Sales, later, for information about deductingpayments in lieu of dividends. Premiums on bonds.If you buy a bond at a premium, the premium is treated as part ofyour basis in the bond. If you choose to amortize the premium paid ona taxable bond, you must reduce the basis of the bond by the amortizedpart of the premium each year over the life of the bond. Although you cannot deduct the premium on a tax-exempt bond, youmust amortize it to determine your adjusted basis in the bond. Youmust reduce the basis of the bond by the premium you amortized for theperiod you held the bond. See Bond Premium Amortization in chapter 3for moreinformation. Market discount on bonds.If you include market discount on a bond in income currently,increase the basis of your bond by the amount of market discount youinclude in your income. See Market Discount Bonds inchapter 1for more information. Acquisition discount on short-term obligations.If you include acquisition discount on a short-term obligation inyour income currently, increase the basis of the obligation by theamount of acquisition discount you include in your income. SeeDiscount on Short-Term Obligations in chapter 1for moreinformation. Original issue discount (OID) on debt instruments.Increase the basis of a debt instrument by the amount of OID thatyou include in your income. See Original Issue Discount (OID)in chapter 1. Discounted tax-exempt obligations.OID on tax-exempt obligations is generally not taxable. However,when you dispose of a tax-exempt obligation issued after September 3,1982, that you acquired after March 1, 1984, you must accrue OID onthe obligation to determine its adjusted basis. The accrued OID isadded to the basis of the obligation to determine your gain or loss. For information on determining OID on a long-term obligation, seeDebt Instruments Issued After July 1, 1982, and Before 1985or Debt Instruments Issued After 1984, whicheverapplies, in Publication 1212 under Figuring OID on Long-Term DebtInstruments. If the tax-exempt obligation has a maturity of 1 year or less,accrue OID under the rules for acquisition discount on short-termobligations. See Discount on Short-Term Obligationsin chapter 1. Stripped tax-exempt obligation.If you acquired a stripped tax-exempt bond or coupon after October22, 1986, you must accrue OID on it to determine its adjusted basiswhen you dispose of it. For stripped tax-exempt bonds or couponsacquired after June 10, 1987, part of this OID may be taxable. Youaccrue the OID on these obligations in the manner described in chapter 1under Stripped Bonds and Coupons. Increase your basis in the stripped tax-exempt bond or coupon bythe taxable and nontaxable accrued OID. Also increase your basis bythe interest that accrued (but was not paid, and was not previouslyreflected in your basis) before the date you sold the bond or coupon.In addition, for bonds acquired after June 10, 1987, add to your basisany accrued market discount not previously reflected in basis.