Other Basis There are many times when you cannot use cost as basis. In thesecases, the FMV or the adjusted basis of property may be used. Adjustedbasis is defined in the preceding discussion, and FMV is defined next. Fair market value (FMV).FMV is the price at which the property would change hands between abuyer and a seller, neither having to buy or sell, and both havingreasonable knowledge of all necessary facts. Sales of similarproperty, on or about the same date, may be helpful in figuring theproperty's FMV. Property Receivedfor Services If you receive property for services, include the property's FMV inincome. The amount you include in income becomes your basis. If theservices were performed for a price agreed on beforehand, it will beaccepted as the FMV of the property if there is no evidence to thecontrary. Bargain Purchases A bargain purchase is a purchase of an item for less than its FMV.If, as compensation for services, you purchase goods or other propertyat less than FMV, include the difference between the purchase priceand FMV of the property in your income. Your basis in the property isits FMV (your purchase price plus the amount you include in income). If the difference between your purchase price and the FMVrepresents a qualified employee discount, do not includethe amount in income. However, your basis in the property is still itsFMV. Restricted Property If you receive property for your services and the property issubject to certain restrictions, your basis in the property is its FMVwhen it becomes substantially vested, unless you make the electiondiscussed later. Property becomes substantially vested when yourrights in the property or the rights of any person to whom youtransfer the property are not subject to a substantial risk offorfeiture. There is substantial risk of forfeiture when the rights to fullenjoyment of the property depend on the future performance ofsubstantial services by any person. When the property becomes substantially vested, include the FMV,less any amount you paid for the property, in income. Example.Your employer gives you stock for services performed under thecondition that you will have to return the stock unless you complete 5years of service. The stock is under a substantial risk of forfeitureand is not substantially vested when you receive it. You need notreport any income until you have completed the 5 years of service thatsatisfy the condition. Fair market value.Figure the FMV of property you received without considering anyrestriction except one that by its terms will never end. Example.For services you performed, you received stock from your employer.If you want to sell the stock while still employed, you must sell thestock to your employer at book value. At your retirement or death, youor your estate must offer to sell the stock to your employer at itsbook value. This is a restriction that by its terms will never end andyou consider it when you figure the FMV. Election.You may choose to include in your gross income the FMV of theproperty at the time of transfer, less any amount you paid for it. Ifyou make this choice, the substantially vested rules do not apply.Your basis is the amount you paid plus the amount you included in yourincome. See the discussion of Restricted Property Received forServices in Publication 525 for more information. Taxable Exchanges A taxable exchange is one in which the gain is taxable or the lossis deductible. If you receive property in exchange for other propertyin a taxable exchange, the basis of property you receive is usuallyits FMV at the time of the exchange. Involuntary Conversions If you receive property as a result of an involuntary conversion,such as a casualty, theft, or condemnation, you may figure the basisof the replacement property you receive using the basis of theconverted property. Similar or related property.If you receive property that is similar or related in service oruse to the converted property, the replacement property's basis is theold property's basis on the date of the conversion with the followingadjustments. Decrease the basis by the following items. Any loss you recognize on the conversion. Any money you receive that you do not spend on similarproperty. Increase the basis by the following items. Any gain you recognize on the conversion. Any cost of acquiring the replacement property. Money or property that is not similar or related.If you receive money or property that is not similar or related inservice or use to the converted property, and you buy replacementproperty that is similar or related in service or use to the convertedproperty, the basis of the new property is its cost, decreased by theamount of gain that is not recognized on the conversion. Example.The state condemned your property. The property had an adjustedbasis of $26,000, and the state paid you $31,000 for it. You realizeda gain of $5,000 ($31,000 - $26,000). You bought replacementproperty that is similar in use to the converted property for $29,000.You recognize a gain of $2,000 ($31,000 - $29,000), the unspentpart of the payment from the state. Your gain not recognized is$3,000, the difference between the $5,000 realized gain and the $2,000recognized gain. The basis of the new property is figured as follows: Cost of replacement property $29,000 Minus: Gain not recognized      3,000 Basis of the replacement property $26,000 Allocating the basis.If you buy more than one piece of replacement property, allocateyour basis among the properties based on their respective costs. Example.The state in the previous example condemned your unimproved realproperty and the replacement property you bought was improved realproperty with both land and buildings. Allocate the replacementproperty's $26,000 basis between land and buildings based on theirrespective costs. More information.For more information about condemnations, see InvoluntaryConversions in Publication 544. For more information aboutcasualty and theft losses, see Publication 547. Nontaxable Exchanges Words you may need to know (see Glossary): Intangible property Like-class property Like-kind property Personal property Real property Tangible property A nontaxable exchange is an exchange in which any gain is not taxedand any loss cannot be deducted. If you receive property in anontaxable exchange, its basis is generally the same as the basis ofthe property you transferred. Like-Kind Exchanges The exchange of property for the same kind of property is the mostcommon type of nontaxable exchange. To qualify as a like-kind exchange, both the property you transferand the property you receive must be held by you for business orinvestment purposes. There must be an exchange of like property. Formore information, see Like-Kind Exchanges in Publication 544. The basis of the property you receive is generally the same as thebasis of the property you gave up. Example.You exchange real estate (adjusted basis $50,000, FMV $80,000) heldfor investment for other real estate (FMV $80,000) held forinvestment. Your basis in the new property is the same as the basis ofthe old ($50,000). Exchange expenses.Exchange expenses are generally the closing costs that you pay.They include such items as brokerage commissions, attorney fees, deedpreparation fees, etc. Add them to the basis of the like-kind propertyreceived. Property plus cash.If you trade property in a like-kind exchange and also pay money,the basis of the property received is the basis of the property yougave up increased by the money paid. Example.You trade in a truck (adjusted basis $3,000) for another truck (FMV$7,500) and pay $4,000. Your basis in the new truck is $7,000 (the$3,000 basis of the old truck plus the $4,000 paid). Special rules for related persons.If a like-kind exchange is made directly or indirectly betweenrelated persons and either party disposes of the property within 2years after the exchange, the exchange is disqualified from like-kindexchange treatment. Each person must report any gain or loss notrecognized on the original exchange. Each person reports it on the taxreturn filed for the year in which the later disposition occurred. Ifthis special rule applies, the basis in the property received in theoriginal exchange will be its fair market value. These rules generally do not apply to the following kinds ofproperty dispositions. Dispositions due to the death of either relatedperson. Involuntary conversions. Dispositions in which neither the original exchange nor thesubsequent disposition had as a main purpose the avoidance of federalincome tax. Related persons.Generally, related persons are ancestors, lineal descendants,brothers and sisters (whole or half), and a spouse. For other related persons (for example, two corporations, anindividual and a corporation, a grantor and fiduciary, etc.), seeNondeductible Loss in chapter 2 of Publication 544. Exchange of businesses.Exchanging the assets of one business for the assets of anotherbusiness is a multiple property exchange. For information ondetermining basis, see Multiple Property Exchanges inPublication 544. Partially Nontaxable Exchange A partially nontaxable exchange is an exchange in which you receiveunlike property or money in addition to like property. The basis ofthe property you receive is the basis of the property you gave up,with the following adjustments. Decrease the basis by the following items. Any money you receive. Any loss you recognize on the exchange. Increase the basis by the following items. Any additional costs you incur. Any gain you recognize on the exchange. If the other party to the transaction assumes any of yourliabilities, or if you transfer property subject to a liability, youwill be treated as if you received money in the amount of theliability. Allocate the basis among the properties, other than money, youreceived in the exchange. In making this allocation, the basis of theunlike property is its FMV on the date of the exchange. The remainderis the basis of the like property. Example 1.You exchange a truck (adjusted basis $6,000) for a new truck (FMV$5,200) and $1,000 cash. You have a recognized gain of $200 ($6,200- $6,000). Your basis in the new truck is: Adjusted basis of old truck $6,000 Minus: Cash received      1,000 $5,000 Plus: Gain recognized        200 Basis of new truck $5,200 Example 2.You had an adjusted basis of $15,000 in real estate you held forinvestment. You exchange it for other real estate to be held forinvestment with an FMV of $12,500, a truck with an FMV of $3,000, and$1,000 cash. You have a gain of $1,500 ($16,500 - $15,000)recognized on the exchange. Your basis in the properties you receivedis: Adjusted basis of real estate transferred $15,000 Minus: Cash received      1,000 $14,000 Plus: Gain recognized      1,500 Total basis of properties received $15,500 Allocate the total basis of $15,500 between the truck and the realestate. The basis of the truck is its FMV, $3,000, and the basis ofthe real estate is the remainder, $12,500. Sale and Purchase If you sell property and buy similar property in two mutuallydependent transactions, you may have to treat the sale and purchase asa single nontaxable exchange. Treat the transaction as an exchange nomatter how it is carried out. You cannot avoid this rule by using asubsidiary in the transaction. Example.You are a salesperson and you use one of your cars 100% forbusiness. You have used this car in your sales activities for 2 yearsand have depreciated it. Your adjusted basis in the car is $22,600 andits FMV is $23,100. You are interested in a new car, which sells for$28,000. If you trade your old car and pay $4,900 for the new one,your basis for depreciation for the new car would be $27,500 ($4,900plus the $22,600 basis of your old car). However, you want a higherbasis for depreciating the new car, so you agree to pay the dealer$28,000 for the new car if he will pay you $23,100 for your old car.Since the sale and purchase are dependent on each other, you aretreated as if you had exchanged your old car for the new one and paid$4,900 ($28,000 - $23,100). Your basis for depreciating the newcar is $27,500, which is the same as it would be if you traded the oldcar. Partial Business Use of Property If you have property used partly for business and partly forpersonal use, and you exchange it in a nontaxable exchange forproperty to be used wholly or partly in your business, the basis ofthe property you receive is figured as if you exchanged twoproperties. The first is an exchange of like-kind property. The secondis personal-use property on which gain is recognized and loss is notrecognized. First, figure your adjusted basis in the property you transfer asif you transferred two separate properties. Figure the adjusted basisof each part of the property by taking into account any adjustments tobasis. Deduct the depreciation you took or could have taken from theadjusted basis of the business part. Then figure the amount realizedfor your property and allocate it to the business and nonbusinessparts of the property you transferred. The business part of the property is permitted to be exchanged taxfree. However, recognize any gain from the exchange of the nonbusinesspart. You are deemed to have received in exchange for the nonbusinesspart an amount equal to its FMV on the date of the exchange. The basisof the property you acquired is the total basis of the propertytransferred (adjusted to the date of the exchange), increased by anygain recognized on the nonbusiness part. TaxTip: If the nonbusiness part of the property you transferred is yourmain home, you may qualify to exclude from income all or part of anygain on that part. For more information, see Publication 523. Traded car used partly in business.If you trade in a car that you used partly in your business foranother car that you will use in your business, your basis fordepreciating the new car is not the same as your basis for figuring again or loss on its sale. For information on figuring your basis for depreciation, seePublication 463. Property TransferredFrom a Spouse The basis of property transferred to you or transferred in trustfor your benefit by your spouse (or former spouse if the transfer isincident to divorce), is the same as the transferor's adjusted basis.However, adjust your basis for any gain recognized by the transferoron a property transferred in trust. This rule applies only to atransfer of property in trust in which the liabilities assumed, plusthe liabilities to which the property is subject, are more than theadjusted basis of the property transferred. If the property transferred to you is a series E, series EE orseries I United States savings bond, the transferor must include inincome the interest accrued to the date of transfer. Your basis in thebond immediately after the transfer is equal to the transferor's basisincreased by the interest income includable in the transferor'sincome. For more information on these bonds, see Publication 550. The transferor must supply you with records necessary to determinethe adjusted basis and holding period of the property as of the dateof transfer. For more information, see Publication 504, Divorced orSeparated Individuals. PropertyReceived as a Gift To figure the basis of property you receive as a gift, you mustknow its adjusted basis (defined earlier) to the donor just before itwas given to you, its FMV at the time it was given to you, and anygift tax paid on it. FMV Less ThanDonor's Adjusted Basis If the FMV of the property is less than the donor's adjusted basis,your basis depends on whether you have a gain or a loss when youdispose of the property. Your basis for figuring gain is the same asthe donor's adjusted basis plus or minus any required adjustment tobasis while you held the property (see Adjusted Basis,earlier). Your basis for figuring loss is its FMV at the timeyou received the gift plus or minus any required adjustment to basiswhile you held the property (see Adjusted Basis, earlier). If you use the donor's adjusted basis for figuring a gain and get aloss, and then use the FMV for figuring a loss and have a gain, youhave neither gain nor loss on the sale or disposition of the property. Example.You received an acre of land as a gift. At the time of the gift,the acre had an FMV of $8,000. The donor's adjusted basis was $10,000.After you received the property, no events occurred to increase ordecrease your basis in it. If you later sell the property for $12,000,you will have a $2,000 gain because you must use the donor's adjustedbasis ($10,000) at the time of the gift as your basis to figure gain.If, however, you sell the property for $7,000, you will have a $1,000loss because you must use the FMV ($8,000) at the time of the gift asyour basis to figure loss. If the sales price is between $8,000 and $10,000, you have neithergain nor loss. For instance, if the sales price was $9,000 and youtried to figure a gain using the donor's adjusted basis ($10,000), youwould get a $1,000 loss. If you then tried to figure a loss using theFMV ($8,000), you would get a $1,000 gain. Business property.If you hold the gift as business property, your basis for figuringany depreciation, depletion, or amortization deduction is the same asthe donor's adjusted basis plus or minus any required adjustments tobasis while you hold the property. FMV Equal to or More ThanDonor's Adjusted Basis If the FMV of the property is equal to or greater than the donor'sadjusted basis, your basis is the donor's adjusted basis at the timeyou received the gift. Increase your basis by all or part of any gifttax paid, depending on the date of the gift. Also, for figuring gain or loss from a sale or other disposition ofthe property or for figuring depreciation, depletion, or amortizationdeductions on business property, you must increase or decrease yourbasis (the donor's adjusted basis) by any required adjustments tobasis while you held the property. See Adjusted Basis,earlier. Gift received before 1977.If you received a gift before 1977, increase your basis in the gift(the donor's adjusted basis) by any gift tax paid on it. However, donot increase your basis above the FMV of the gift at the time it wasgiven to you. Example 1.You were given a house in 1976 with an FMV of $21,000. The donor'sadjusted basis was $20,000. The donor paid a gift tax of $500. Yourbasis is $20,500, the donor's adjusted basis plus the gift tax paid. Example 2.If, in Example 1, the gift tax paid had been $1,500, your basiswould be $21,000. This is the donor's adjusted basis plus the gift taxpaid, limited to the FMV of the house at the time you received thegift. Gift received after 1976.If you received a gift after 1976, increase your basis in the gift(the donor's adjusted basis) by the part of the gift tax paid on itthat is due to the net increase in value of the gift. Figure theincrease by multiplying the gift tax paid by a fraction. The numerator(top part) of the fraction is the net increase in value of the gift,and the denominator (bottom part) is the amount of the gift. The net increase in value of the gift is the FMV of the gift minusthe donor's adjusted basis. The amount of the gift is its value forgift tax purposes after reduction by any annual exclusion and maritalor charitable deduction that applies to the gift. For information onthe gift tax, see Publication 950, Introduction to Estate andGift Taxes. Example.In 1999, you received a gift of property from your mother that hadan FMV of $50,000. Her adjusted basis was $20,000. The amount of thegift for gift tax purposes was $40,000 ($50,000 minus the $10,000annual exclusion). She paid a gift tax of $9,000. Your basis, $26,750,is figured as follows: Fair market value $50,000 Minus: Adjusted basis     20,000 Net increase in value    $30,000 Gift tax paid $9,000 Multiplied by ($30,000 $40,000)        .75 Gift tax due to net increase in value $6,750 Adjusted basis of property to your mother     20,000 Your basis in the property $26,750 Inherited Property hotel rooms MontpellierYour basis in property you inherit from a decedent is generally oneof the following. The FMV of the property at the date of the individual'sdeath. The FMV on the alternate valuation date, if the personalrepresentative for the estate chooses to use alternate valuation. Forinformation on the alternate valuation date, see the instructions forForm 706. The value under the special-use valuation method for realproperty used in farming or other closely held business, if chosen forestate tax purposes. This method is discussed later. The decedent's adjusted basis in land to the extent of thevalue that is excluded from the decedent's taxable estate as aqualified conservation easement. If a federal estate tax return does not have to be filed, yourbasis in the inherited property is its appraised value at the date ofdeath for state inheritance or transmission taxes. Appreciated property.The above rule does not apply to appreciated property you receivefrom a decedent if you or your spouse originally gave the property tothe decedent within 1 year before the decedent's death. Your basis inthis property is the same as the decedent's adjusted basis in theproperty immediately before his or her death, rather than its FMV.Appreciated property is any property whose FMV on the day it was givento the decedent is more than its adjusted basis. Community Property In community property states (Arizona, California, Idaho,Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin),husband and wife are each usually considered to own half the communityproperty. When either spouse dies, the total value of the communityproperty, even the part belonging to the surviving spouse, generallybecomes the basis of the entire property. For this rule to apply, atleast half the value of the community property interest must beincludable in the decedent's gross estate, whether or not the estatemust file a return. For example, you and your spouse owned community property that hada basis of $80,000. When your spouse died, at least half the FMV ofthe community interest was includable in your spouse's estate. The FMVof the community interest was $100,000. The basis of your half of theproperty is $50,000 (one half of the $100,000 FMV). The basis of theother half to your spouse's heirs is also $50,000. For more information on community property, see Publication 555. Property Held by Surviving Tenant The following example explains the rule for the basis of propertyheld by a surviving tenant in a joint tenancy or tenancy by theentirety. Example.John and Jim owned, as joint tenants with right of survivorship,business property that they purchased for $30,000. John furnishedtwo-thirds of the purchase price and Jim furnished one-third.Depreciation deductions allowed before John's death were $12,000.Under local law, each had a half interest in the income from theproperty. At the date of John's death, the property had an FMV of$60,000, two-thirds of which is includable in John's estate. Jimfigures his basis in the property at the date of John's death asfollows: Interest Jim bought with his own funds-- 1/3 of $30,000 cost $10,000 Interest Jim received on John's death-- 2/3 of $60,000 FMV     40,000 $50,000 Minus: 1/2 of $12,000 depreciationbefore John's death      6,000 Jim's basis at the date of John's death $44,000 If Jim had not contributed any part of the purchase price, hisbasis at the date of John's death would be $54,000. This is figured bysubtracting from the $60,000 FMV, the $6,000 depreciation allocated toJim's half interest before the date of death. If, under local law, Jim had no interest in the income from theproperty and if he contributed no part of the purchase price, hisbasis at John's death would be $60,000. This $60,000 is the FMV of theproperty. Qualified Joint Interest Include one-half of the value of a qualified joint interest in thedecedent's gross estate. It does not matter how much each spousecontributed to the purchase price. Also, it does not matter whichspouse dies first. A qualified joint interest is any interest in property held byhusband and wife as either of the following. Tenants by the entirety. Joint tenants with right of survivorship, if husband andwife are the only joint tenants. Basis.As the surviving spouse, your basis in property that you owned withyour spouse as a qualified joint interest is the cost of your half ofthe property with some adjustments. Decrease the cost by anydeductions allowed to you for depreciation and for depletion. Increasethe reduced cost by your basis in the half you inherited. Farm or Closely Held Business Under certain conditions, when a person dies the executor orpersonal representative of that person's estate may choose to valuethe qualified real property on other than its FMV. If so, the executoror personal representative values the qualified real property based onits use as a farm or its use in a closely held business. If theexecutor or personal representative chooses this method of valuationfor estate tax purposes, that value is the basis of the property forthe heirs. The qualified heirs should be able to get the necessaryvalue from the executor or personal representative of the estate. If you are a qualified heir who received special-use valuationproperty, your basis in the property is the estate's or trust's basisin that property immediately before the distribution. Increase yourbasis by any gain recognized by the estate or trust because ofpost-death appreciation. Post-death appreciation is the property's FMVon the date of distribution minus the property's FMV either on thedate of the individual's death or the alternate valuation date. Figureall FMVs without regard to the special-use valuation. You can elect to increase your basis in special-use valuationproperty if it becomes subject to the additional estate tax. This taxis assessed if, within 10 years after the death of the decedent, youtransfer the property to a person who is not a member of your familyor the property stops being used as a farm or in a closely heldbusiness. To increase your basis in the property, you must make anirrevocable election and pay interest on the additional estate taxfigured from the date 9 months after the decedent's death until thedate of the payment of the additional estate tax. If you meet theserequirements, increase your basis in the property to its FMV on thedate of the decedent's death or the alternate valuation date. Theincrease in your basis is considered to have occurred immediatelybefore the event that results in the additional estate tax. You make the election by filing with Form 706-A a statement thatdoes all of the following. Contains your (and the estate's) name, address, and taxpayeridentification number. Identifies the election as an election under section 1016(c)of the Internal Revenue Code. Specifies the property for which the election ismade. Provides any additional information required by the Form706-A instructions. For more information, see the instructions for Form 706 and Form706-A. Property Changed toBusiness or Rental Use When you hold property for personal use and change it to businessuse or use it to produce rent, you must figure its basis fordepreciation. An example of changing property held for personal use tobusiness use would be renting out your former main home. Basis for depreciation.The basis for depreciation is the lesser of the following amounts. The FMV of the property on the date of the change. Your adjusted basis on the date of the change. Example.Several years ago you paid $160,000 to have your home built on alot that cost you $25,000. Before changing the property to rental uselast year, you paid $20,000 for permanent improvements to the houseand claimed a $2,000 casualty loss deduction for damage to the house.Because land is not depreciable, you can only include the cost of thehouse when figuring the basis for depreciation. Your adjusted basis in the house when you change its use is$178,000 ($160,000 + $20,000 - $2,000). On the date ofchange in use, your property has an FMV of $180,000, of which $15,000is for the land and $165,000 is for the house. The basis for figuringdepreciation on the house is the FMV on the date of change ($165,000),because it is less than your adjusted basis ($178,000). Sale of property.If you later sell or dispose of the property, the basis of theproperty you use will depend on whether you are figuring gain or loss. Gain.The basis for figuring a gain is your adjusted basis when you sellthe property. Example.Assume the same facts as in the previous example, except that yousell the property at a gain after being allowed depreciationdeductions of $37,500. Your adjusted basis for figuring gain is$165,500 ($178,000 + $25,000 (land) - $37,500). Loss.Figure the basis for a loss starting with the smaller of youradjusted basis or the FMV of the property at the time of the change tobusiness/rental use. Example.Assume the same facts as in the previous example, except that yousell the property at a loss after being allowed depreciationdeductions of $37,500. In this case, you would start with the FMV($180,000) on the date of the change to rental use, because it is lessthan the adjusted basis of $203,000 ($178,000 + $25,000) on thatdate. Reduce that amount ($180,000) by the amount of depreciationdeductions to arrive at a basis for loss of $142,500($180,000-$37,500).