Adjustments to basis

Your basis is the amount of your investment in property for tax purposes. You use it to figure depreciation, amortization, depletion, and casualty losses. You also use it to figure gain or loss when you sell or otherwise dispose of property.

Your basis in property is generally its cost. Exceptions can apply under other provisions of the same subchapter and under subchapters C, K, and P. Those subchapters address corporate distributions and adjustments, partners and partnerships, and capital gains and losses.

Your adjusted basis for determining gain or loss starts with the basis determined under section 1012 or another applicable provision. You then apply the adjustments provided in section 1016. This rule applies to property whenever you acquired it.

Before you figure gain or loss on a sale, exchange, or other disposition, you must usually make increases and decreases to your property's basis. You increase basis for capital improvements. You decrease basis for depreciation, amortization, and depletion.

For your home, adjusted basis is generally your acquisition cost plus the cost of capital improvements you made, less casualty loss amounts and other decreases. Your calculation therefore includes both additions to your investment and amounts that reduce your basis.

If you financed your home purchase with a mortgage, the purchase price includes the mortgage proceeds. Those proceeds are therefore already included in your adjusted cost basis in the home.

You must keep accurate records of all items that affect your property's basis. You need those records for your depreciation, amortization, depletion, casualty loss, and gain or loss computations.

To calculate a positive gain when you sell or otherwise dispose of property, subtract the section 1011 basis applicable to gains from the amount realized. To calculate a loss when that section's basis applicable to losses exceeds what you realized, subtract the amount realized from that basis.

You must use the adjusted basis that applies to the computation you are making. For gifted property whose fair market value at the time of the gift was below the donor's adjusted basis, your basis depends on whether you have a gain or a loss when you dispose of it.

You can have neither gain nor loss on that gifted property. This happens if using the donor's adjusted basis to figure gain produces a loss, while using fair market value to figure loss produces a gain.

If you used property for personal purposes before changing it to rental use, your basis for depreciation is the lesser of its adjusted basis or its fair market value when you make the change.

If you buy buildings and your purchase cost includes the land beneath them, you must divide that cost between the land and buildings to figure the buildings' basis for depreciation. You allocate cost to each asset according to its fair market value relative to the fair market value of the whole property when you buy it.

Under MACRS GDS, you depreciate residential rental property using the straight line method over 27.5 years. You must use a convention that treats the property as placed in service in the middle of the month. In your first year of depreciation, you can claim depreciation only for the number of months the property is in use under that convention.

When you sell your home, you must adjust basis for depreciation deducted in earlier years. Your home sale exclusion does not apply to gain from depreciation adjustments attributable to periods after May 6, 1997. You do not count that gain when determining the amount of gain allocated to business or rental use.

If you convert rental property into your primary residence, you stop claiming additional depreciation at that point. Depreciation recapture occurs when you sell the property.

You generally calculate your home's adjusted basis by adding improvement costs to what you paid to acquire it, then subtracting casualty losses and other reductions. For the home sale calculation, you must reflect deductions you took for depreciation in prior tax years.

If you dispose of section 1245 property at a gain, your gain is ordinary income to the extent of depreciation allowed or allowable on the property. Any recognized gain above the portion treated as ordinary income from depreciation is section 1231 gain.

For section 1250 purposes, your property is section 1250 property if it is real property other than section 1245 property and is or has been of a character subject to the depreciation allowance under section 167.

Section 1250 recapture generally applies if you used an accelerated depreciation method or claimed a special depreciation allowance or the commercial revitalization deduction. For section 1250 real property you held more than a year, the recapture rules treat certain gains as ordinary income to the extent they result from depreciation previously claimed above straight line depreciation.

You generally use the greater of depreciation allowed or allowable when figuring the gain reported as ordinary income. This includes depreciation for another person who held the property if that depreciation was used in figuring your adjusted basis. If you can show that the deduction allowed for a tax year was less than the amount allowable, you use the lesser amount as the depreciation adjustment for figuring additional depreciation.

Your unrecaptured section 1250 gain is generally the part of your capital gain from selling section 1250 real property attributable to depreciation. It cannot exceed your net section 1231 gain and is reduced by any net loss in the 28% group. You figure it using the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions.

If you report a property sale under the installment method, any depreciation recapture under section 1245 or 1250 is taxable as ordinary income in the year of sale. This applies even if you receive no payments that year. If your gain exceeds your depreciation recapture income, you report the remaining gain under the installment method rules.

If you sell property for which you claimed or could have claimed depreciation, you figure depreciation recapture income in Part III of Form 4797. This includes section 179 deduction recapture and section 179A deduction recapture. You report the recapture income as ordinary income in Part II in the year of sale, whether or not you receive an installment payment that year.

If you receive a gift whose fair market value is less than the donor's adjusted basis at the time of the gift, your basis for figuring gain is the donor's adjusted basis. You increase or decrease that basis for any required adjustments while you hold the property.

If you give depreciable personal property or real property as a gift, you do not have to report income on the transaction. If you receive that property and later dispose of it in a transaction subject to recapture, you must account for the donor's depreciation deductions when figuring the gain reported as ordinary income.

For certain appreciated property you inherit, your basis is the decedent's adjusted basis immediately before death rather than fair market value. This applies if you or your spouse gave that appreciated property to the decedent during the 1 year period ending on the date of death.

If you receive property from your spouse or former spouse in a transfer on which gain or loss is not recognized, you treat the transfer as a gift rather than a sale or exchange. You take the giver's adjusted basis immediately before the transfer.

This carryover basis rule applies whether that adjusted basis is less than, equal to, or greater than the property's fair market value at the transfer. It also applies whether that basis is less than, equal to, or greater than any consideration you paid.

Under section 704(d), your distributive share of partnership loss, including capital loss, is generally allowed only to the extent of your adjusted basis in your partnership interest. This is your outside basis, measured at the end of the partnership year in which the loss occurred.

If you contribute property to a partnership, the partnership's basis for depreciation, depletion, gain, or loss is your adjusted basis when you contributed it. The partnership increases that basis by any gain you recognized at the time of contribution.

Unless your partnership interest is completely liquidated, your basis in property other than money distributed to you is the partnership's adjusted basis immediately before distribution. Your basis in that property cannot exceed your adjusted basis in your partnership interest reduced by any money you receive in the same transaction.

Once you have adjusted your basis to zero, you report additional returns or distributions other than dividend distributions on Schedule D and Form 8949. If you held the stock longer than a year, you report any resulting gains as long term capital gain.