Cost Basis Words you may need to know (see Glossary): Business assets Nonbusiness assets Real property Unstated interest The basis of property you buy is usually its cost. The cost is theamount you pay in cash, debt obligations, or other property. Your costalso includes amounts you pay for the following items. Sales tax charged on the purchase. Bordeaux hotel roomsFreight charges to obtain the property. Installation and testing charges. Excise taxes. Legal and accounting fees (when they must becapitalized). Revenue stamps. Recording fees. Real estate taxes (if assumed for the seller). In addition, the basis of real property and business assets mayinclude other items. Loans with low or no interest.If you buy business or investment property on any time-payment planthat charges little or no interest, the basis of your property is yourstated purchase price, less the amount considered to be unstatedinterest. You generally have unstated interest if your interest rateis less than the applicable federal rate. See the discussion ofunstated interest in Publication 537. Purchase of a business.When you purchase a trade or business, you generally purchase allassets used in the business operations, such as land, buildings, andmachinery. You must spread the price among the various assetsincluding any section 197 intangibles, such as goodwill. SeeAllocating the Basis, later. Stocks and Bonds The basis of stocks or bonds you buy is the purchase price plus anycosts of purchase such as any commissions and recording or transferfees. If you acquired stock through an automatic investment program,dividend reinvestment plan, stock dividend, or by exercising stockrights, see Stocks and Bonds in chapter 4 of Publication 550 for information on basis. 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. If you buy and sell securities at various times invarying quantities and you cannot adequately identify the shares yousell, the basis of the securities you sell is the basis of thesecurities you acquired first. Mutual fund shares.If you sell mutual fund shares that you acquired at different timesand prices, you may choose to use an average basis. For moreinformation, see Average Basis in Publication 564. Real Property If you buy real property, certain fees and other expenses you payare part of your basis in the property. Real estate taxes.If you pay real estate taxes that the seller owed on real propertyyou bought, and the seller did not reimburse you, treat those taxes aspart of your basis. You cannot deduct them as taxes. If you reimburse the seller for taxes the seller paid for you, youcan usually deduct that amount. Do not include that amount in thebasis of the property. If you did not reimburse the seller, you mustreduce your basis by the amount of those taxes. Settlement costs.You can include in the basis of property you purchase thesettlement fees and closing costs that are for buying the property.You cannot include fees and costs for getting a loan on the property.(A fee is for buying property if you would have had to pay it even ifyou bought the property for cash.) Zimmer TartuThe following are some of the settlement fees or closing costs thatyou can include in the basis of your property. Abstract fees (abstract of title fees). Charges for installing utility services. Legal fees (including title search and preparation of thesales contract and deed). Recording fees. Surveys. Transfer taxes. Title insurance. Any amounts the seller owes that you agree to pay, such asback taxes or interest, recording or mortgage fees, charges forimprovements or repairs, and sales commissions. Settlement costs do not include amounts placed in escrowfor the future payment of items such as taxes and insurance. The following are some of the settlement fees and closing coststhat you cannot include in the basis of the property. Fire insurance premiums. Rent for occupancy of the property before closing. Charges for utilities or other services related to occupancyof the property before closing. Charges connected with getting a loan. The following areexamples of these charges. Points (discount points, loan origination fees). Mortgage insurance premiums. Loan assumption fees. Cost of a credit report. Fees for an appraisal required by a lender. Fees for refinancing a mortgage. Points.hôtels AarhusIf you pay points to obtain a loan (including a mortgage, secondmortgage, line of credit, or a home equity loan), do not add thepoints to the basis of the related property. Generally, you deduct thepoints over the term of the loan. For more information on how todeduct points, see Points in chapter 8 of Publication 535,Business Expenses. Points on home mortgage.Special rules may apply to points you and the seller pay when youobtain a mortgage to purchase your main home. If certain requirementsare met, you can deduct the points in full for the year in which theyare paid. If you deduct seller-paid points, reduce the basis of yourhome by that amount. For more information, see Points inPublication 936, Home Mortgage Interest Deduction. Assumption of mortgage.If you buy property and assume (or buy subject to) an existingmortgage on the property, your basis includes the amount you pay forthe property plus the amount to be paid on the mortgage you assume. Example.ERROR MSGIf you buy a building for $20,000 and assume a mortgage of $80,000on it, your basis is $100,000. Constructing nonbusiness assets.If you build nonbusiness property (for example, your home) or haveassets built for you, the expenses you pay for this construction arepart of your basis. The following items are some examples of theseexpenses. The cost of land. The cost of labor and materials. Architect's fees. Building permit charges. Payments to contractors. Payments for rental equipment. Inspection fees. In addition, if you own a business and use your employees,material, and equipment to construct a nonbusiness asset, your basiswould also include the following items. Employee compensation paid for the construction work. Depreciation on your equipment while it is used in theconstruction. Operating and maintenance costs for equipment used in theconstruction. The cost of business supplies and materials used in theconstruction. Do not deduct these expenses. You must capitalize them (includethem in the asset's basis). Also, reduce your basis by any workopportunity credit, welfare-to-work credit, Indian employment credit,or empowerment zone employment credit allowable on the wages you payin (1), above. Do not include the value of your own labor, or any other labor youdid not pay for, in the basis of any property you construct. Business Assets Words you may need to know (see Glossary): Amortization Capital assets Capital expenses Capitalization Depletion Depreciation Fair market value Going concern value Goodwill Intangible property Personal property Recapture Section 179 deduction Section 197 intangibles Tangible property If you purchase property to use in your business, your basis isusually its actual cost to you. If you construct, create, or otherwiseproduce property, you must capitalize the costs as your basis. Incertain circumstances, you may be subject to the uniformcapitalization rules, next. Uniform Capitalization Rules The uniform capitalization rules specify the costs you add to basisin certain circumstances. Who must use.You must use the uniform capitalization rules if you do any of thefollowing in your trade or business or activity carried on for profit. Produce real or tangible personal property for use in thebusiness or activity. Produce real or tangible personal property for sale tocustomers. Acquire property for resale. You produce property if you construct, build, install, manufacture,develop, improve, create, raise or grow the property. Treat theproperty produced for you under a contract as produced by you up tothe amount you pay or costs you otherwise incur for the property.Tangible personal property includes films, sound recordings, videotapes, books, or similar property. Under the uniform capitalization rules, generally you mustcapitalize all direct costs and an allocable part of most indirectcosts incurred during the year due to production or resale activities.You must include these costs in the basis of property you produce orin your inventory costs, rather than deduct them as a current expense.You recover these costs through depreciation, amortization, or cost ofgoods sold when you use, sell, or otherwise dispose of the property. Any cost that you could not use to figure your taxable income forany tax year is not subject to the uniform capitalization rules. Example.If you incur a business meal expense for which your deduction wouldbe limited to 50% of the cost of the meal, that amount is subject tothe uniform capitalization rules. The part of the cost that is notdeductible is not subject to the uniform capitalization rules. More information.For more information on the uniform capitalization rules, see theregulations under section 263A of the Internal Revenue Code andPublication 538, Accounting Periods and Methods. Exceptions.The following are not subject to the uniform capitalization rules. Property you produce that you do not use in your trade,business, or activity conducted for profit. Qualified creative expenses you pay or incur as a free-lance(self-employed) writer, photographer, or artist that are otherwisedeductible on your tax return. Property you produce under a long-term contract, except forcertain home construction contracts. Research and experimental expenses allowable as a deductionunder section 174 of the Internal Revenue Code. Costs for personal property acquired for resale if your (oryour predecessor's) average annual gross receipts for the 3 previoustax years do not exceed $10 million. For other exceptions to the uniform capitalization rules, seesection 1.263A-1(b) of the regulations. For information on the special rules that apply to costs incurredin the business of farming, see chapter 7 of Publication 225,Farmer's Tax Guide. Intangible Assets Intangible assets include goodwill, patents, copyrights,trademarks, trade names, and franchises. The basis of an intangibleasset is usually the cost to buy or create it. If you acquire multipleassets, for example a going business for a lump sum, seeAllocating the Basis, later, to figure the basis of theindividual assets. The basis of certain intangibles can be amortized.See chapter 12 of Publication 535 for information on the amortizationof these costs. Patents.The basis of a patent you get for your invention is the cost ofdevelopment, such as research and experimental expenditures, drawings,working models, and attorneys' and governmental fees. If you deductthe research and experimental expenditures as current businessexpenses, you cannot include them in the basis of the patent. Thevalue of the inventor's time spent on an invention is not part of thebasis. Copyrights.If you are an author, the basis of the copyright for your workusually will be your cost of getting the copyright plus copyrightfees, attorneys' fees, clerical assistance, and the cost of platesthat remain in your possession. Do not include in the basis the valueof your time as the author, or any other person's time you did not payfor. Franchises, trademarks, and trade names.If you buy a franchise, trademark, or trade name, the basis is itscost, unless you can deduct your payments as a business expense. Allocating the Basis If you buy multiple assets for a lump sum, allocate the amount youpay to each of the assets you receive. Make this allocation to figureyour basis for depreciation and gain or loss on a later disposition ofany of these assets. See Trade or Business Acquired, later. Group of Assets Acquired If you buy multiple assets for a lump sum, you and the seller mayagree to a specific allocation of the purchase price to each asset inthe sales contract. If this allocation is based on the value of eachasset and you and the seller have adverse tax interests, theallocation generally will be accepted. However, see Trade orBusiness Acquired, next. Trade or Business Acquired If you acquire a group of assets that is a trade or business,allocate the purchase price to the various assets acquired. Make the allocation among the assets in proportion to (but not inexcess of) their fair market value (FMV) on the purchase date in thefollowing order. Cash, demand deposits, and similar accounts. Certificates of deposit, U.S. Government securities, readilymarketable stock or securities, and foreign currency. All other assets except section 197 intangibles. Section 197 intangibles (other than goodwill and goingconcern value). Section 197 intangibles in the nature of goodwill and goingconcern value. Agreement.If you and the seller agree in writing to allocate theconsideration, or the FMV of any asset, the agreement is binding onboth you and the seller unless the IRS determines that the amounts arenot appropriate. Reporting requirement.Both the buyer and seller of a trade or business must report to theIRS the allocation of the sales price among section 197 intangiblesand the other business assets. Use Form 8594 to provide thisinformation. The buyer and seller should each attach Form 8594 totheir federal income tax returns for the year in which the saleoccurred. Land and Buildings If you buy buildings and the land on which they stand for yourbusiness and you pay a lump sum for it, allocate the basis of thewhole property among the land and buildings so you can figure thedepreciation allowable on the buildings. Figure the basis of each asset by multiplying the lump sum you paidby a fraction. The numerator of the fraction is the FMV of that assetand the denominator is the FMV of the whole property at the time youget the property. If you are not certain of the FMV of the land andbuildings, you may allocate the basis among them based on theirassessed values for real estate tax purposes. Demolition of building.Add demolition costs and other losses incurred for the demolitionof any building to the basis of the land on which the demolishedbuilding was located. Do not claim them as a current deduction. Modification of building.A modification of a building will not be treated as a demolition ifthe following conditions are satisfied. 75 percent or more of the existing external walls of thebuilding are retained in place as internal or external walls. 75 percent or more of the existing internal structuralframework of the building is retained in place. If the building is a certified historic structure themodification must also be part of a certified rehabilitation. If these conditions are met, add the costs of the modifications tothe basis of the building. Subdivided lots.If you buy a tract of land and subdivide it, you must determine thebasis of each lot. This is necessary because you must figure the gainor loss on the sale of each individual lot. As a result, you do notrecover your entire cost in the tract until you have sold all of thelots. To determine the basis of an individual lot, multiply the totalcost of the tract by a fraction. The numerator (top part) is the FMVof the lot and the denominator (bottom part) is the FMV of the entiretract. Future improvement costs.If you are a developer and sell subdivided lots before thedevelopment work is completed, you can (with IRS consent) include inthe basis of the properties sold an allocation of the estimated futurecost for common improvements. See Revenue Procedure 92-29 formore information, including an explanation of the procedures forgetting consent from the IRS. Use of erroneous cost basis.ERROR MSGIf you made a mistake in figuring the cost basis of subdivided lotsthat you sold in previous years, you cannot correct the mistake foryears for which the statute of limitations has expired. Figure thebasis of any remaining lots by allocating the correct original costbasis of the entire tract among the original lots. Example.You bought a tract of land to which you assigned a cost of $15,000.You subdivided the land into 15 building lots of equal size andequitably divided your basis so that each lot had a basis of $1,000.You treated the sale of each lot as a separate transaction and figuredgain or loss separately on each sale. Several years later you determine that your original basis in thetract was $22,500 and not $15,000. You sold eight lots using $8,000 ofbasis in years for which the statute of limitations has expired. Younow can take $1,500 of basis into account for figuring gain or lossonly on the sale of each of the remaining seven lots ($22,500 basisdivided among all 15 lots). You cannot refigure (to $1,500) the basisof the eight lots sold in tax years barred by the statute oflimitations.