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Hrblock freefile 1. Hrblock freefile   Overview of Depreciation Table of Contents Introduction Useful Items - You may want to see: What Property Can Be Depreciated?Property You Own Property Used in Your Business or Income-Producing Activity Property Having a Determinable Useful Life Property Lasting More Than One Year What Property Cannot Be Depreciated?Land Excepted Property When Does Depreciation Begin and End?Placed in Service Idle Property Cost or Other Basis Fully Recovered Retired From Service What Method Can You Use To Depreciate Your Property?Property You Placed in Service Before 1987 Property Owned or Used in 1986 Intangible Property Corporate or Partnership Property Acquired in a Nontaxable Transfer Election To Exclude Property From MACRS What Is the Basis of Your Depreciable Property?Cost as Basis Other Basis Adjusted Basis How Do You Treat Repairs and Improvements? Do You Have To File Form 4562? How Do You Correct Depreciation Deductions?Filing an Amended Return Changing Your Accounting Method Introduction Depreciation is an annual income tax deduction that allows you to recover the cost or other basis of certain property over the time you use the property. Hrblock freefile It is an allowance for the wear and tear, deterioration, or obsolescence of the property. Hrblock freefile This chapter discusses the general rules for depreciating property and answers the following questions. Hrblock freefile What property can be depreciated? What property cannot be depreciated? When does depreciation begin and end? What method can you use to depreciate your property? What is the basis of your depreciable property? How do you treat repairs and improvements? Do you have to file Form 4562? How do you correct depreciation deductions? Useful Items - You may want to see: Publication 534 Depreciating Property Placed in Service Before 1987 535 Business Expenses 538 Accounting Periods and Methods 551 Basis of Assets Form (and Instructions) Sch C (Form 1040) Profit or Loss From Business Sch C-EZ (Form 1040) Net Profit From Business 2106 Employee Business Expenses 2106-EZ Unreimbursed Employee Business Expenses 3115 Application for Change in Accounting Method 4562 Depreciation and Amortization See chapter 6 for information about getting publications and forms. Hrblock freefile What Property Can Be Depreciated? You can depreciate most types of tangible property (except land), such as buildings, machinery, vehicles, furniture, and equipment. Hrblock freefile You also can depreciate certain intangible property, such as patents, copyrights, and computer software. Hrblock freefile To be depreciable, the property must meet all the following requirements. Hrblock freefile It must be property you own. Hrblock freefile It must be used in your business or income-producing activity. Hrblock freefile It must have a determinable useful life. Hrblock freefile It must be expected to last more than one year. Hrblock freefile The following discussions provide information about these requirements. Hrblock freefile Property You Own To claim depreciation, you usually must be the owner of the property. Hrblock freefile You are considered as owning property even if it is subject to a debt. Hrblock freefile Example 1. Hrblock freefile You made a down payment to purchase rental property and assumed the previous owner's mortgage. Hrblock freefile You own the property and you can depreciate it. Hrblock freefile Example 2. Hrblock freefile You bought a new van that you will use only for your courier business. Hrblock freefile You will be making payments on the van over the next 5 years. Hrblock freefile You own the van and you can depreciate it. Hrblock freefile Leased property. Hrblock freefile   You can depreciate leased property only if you retain the incidents of ownership in the property (explained below). Hrblock freefile This means you bear the burden of exhaustion of the capital investment in the property. Hrblock freefile Therefore, if you lease property from someone to use in your trade or business or for the production of income, you generally cannot depreciate its cost because you do not retain the incidents of ownership. Hrblock freefile You can, however, depreciate any capital improvements you make to the property. Hrblock freefile See How Do You Treat Repairs and Improvements later in this chapter and Additions and Improvements under Which Recovery Period Applies in chapter 4. Hrblock freefile   If you lease property to someone, you generally can depreciate its cost even if the lessee (the person leasing from you) has agreed to preserve, replace, renew, and maintain the property. Hrblock freefile However, if the lease provides that the lessee is to maintain the property and return to you the same property or its equivalent in value at the expiration of the lease in as good condition and value as when leased, you cannot depreciate the cost of the property. Hrblock freefile Incidents of ownership. Hrblock freefile   Incidents of ownership in property include the following. Hrblock freefile The legal title to the property. Hrblock freefile The legal obligation to pay for the property. Hrblock freefile The responsibility to pay maintenance and operating expenses. Hrblock freefile The duty to pay any taxes on the property. Hrblock freefile The risk of loss if the property is destroyed, condemned, or diminished in value through obsolescence or exhaustion. Hrblock freefile Life tenant. Hrblock freefile   Generally, if you hold business or investment property as a life tenant, you can depreciate it as if you were the absolute owner of the property. Hrblock freefile However, see Certain term interests in property under Excepted Property, later. Hrblock freefile Cooperative apartments. Hrblock freefile   If you are a tenant-stockholder in a cooperative housing corporation and use your cooperative apartment in your business or for the production of income, you can depreciate your stock in the corporation, even though the corporation owns the apartment. Hrblock freefile   Figure your depreciation deduction as follows. Hrblock freefile Figure the depreciation for all the depreciable real property owned by the corporation in which you have a proprietary lease or right of tenancy. Hrblock freefile If you bought your cooperative stock after its first offering, figure the depreciable basis of this property as follows. Hrblock freefile Multiply your cost per share by the total number of outstanding shares, including any shares held by the corporation. Hrblock freefile Add to the amount figured in (a) any mortgage debt on the property on the date you bought the stock. Hrblock freefile Subtract from the amount figured in (b) any mortgage debt that is not for the depreciable real property, such as the part for the land. Hrblock freefile Subtract from the amount figured in (1) any depreciation for space owned by the corporation that can be rented but cannot be lived in by tenant-stockholders. Hrblock freefile Divide the number of your shares of stock by the total number of outstanding shares, including any shares held by the corporation. Hrblock freefile Multiply the result of (2) by the percentage you figured in (3). Hrblock freefile This is your depreciation on the stock. Hrblock freefile   Your depreciation deduction for the year cannot be more than the part of your adjusted basis in the stock of the corporation that is allocable to your business or income-producing property. Hrblock freefile You must also reduce your depreciation deduction if only a portion of the property is used in a business or for the production of income. Hrblock freefile Example. Hrblock freefile You figure your share of the cooperative housing corporation's depreciation to be $30,000. Hrblock freefile Your adjusted basis in the stock of the corporation is $50,000. Hrblock freefile You use one half of your apartment solely for business purposes. Hrblock freefile Your depreciation deduction for the stock for the year cannot be more than $25,000 (½ of $50,000). Hrblock freefile Change to business use. Hrblock freefile   If you change your cooperative apartment to business use, figure your allowable depreciation as explained earlier. Hrblock freefile The basis of all the depreciable real property owned by the cooperative housing corporation is the smaller of the following amounts. Hrblock freefile The fair market value of the property on the date you change your apartment to business use. Hrblock freefile This is considered to be the same as the corporation's adjusted basis minus straight line depreciation, unless this value is unrealistic. Hrblock freefile The corporation's adjusted basis in the property on that date. Hrblock freefile Do not subtract depreciation when figuring the corporation's adjusted basis. Hrblock freefile   If you bought the stock after its first offering, the corporation's adjusted basis in the property is the amount figured in (1), above. Hrblock freefile The fair market value of the property is considered to be the same as the corporation's adjusted basis figured in this way minus straight line depreciation, unless the value is unrealistic. Hrblock freefile   For a discussion of fair market value and adjusted basis, see Publication 551. Hrblock freefile Property Used in Your Business or Income-Producing Activity To claim depreciation on property, you must use it in your business or income-producing activity. Hrblock freefile If you use property to produce income (investment use), the income must be taxable. Hrblock freefile You cannot depreciate property that you use solely for personal activities. Hrblock freefile Partial business or investment use. Hrblock freefile   If you use property for business or investment purposes and for personal purposes, you can deduct depreciation based only on the business or investment use. Hrblock freefile For example, you cannot deduct depreciation on a car used only for commuting, personal shopping trips, family vacations, driving children to and from school, or similar activities. Hrblock freefile    You must keep records showing the business, investment, and personal use of your property. Hrblock freefile For more information on the records you must keep for listed property, such as a car, see What Records Must Be Kept in chapter 5. Hrblock freefile    Although you can combine business and investment use of property when figuring depreciation deductions, do not treat investment use as qualified business use when determining whether the business-use requirement for listed property is met. Hrblock freefile For information about qualified business use of listed property, see What Is the Business-Use Requirement in chapter 5. Hrblock freefile Office in the home. Hrblock freefile   If you use part of your home as an office, you may be able to deduct depreciation on that part based on its business use. Hrblock freefile For information about depreciating your home office, see Publication 587. Hrblock freefile Inventory. Hrblock freefile   You cannot depreciate inventory because it is not held for use in your business. Hrblock freefile Inventory is any property you hold primarily for sale to customers in the ordinary course of your business. Hrblock freefile   If you are a rent-to-own dealer, you may be able to treat certain property held in your business as depreciable property rather than as inventory. Hrblock freefile See Rent-to-own dealer under Which Property Class Applies Under GDS in chapter 4. Hrblock freefile   In some cases, it is not clear whether property is held for sale (inventory) or for use in your business. Hrblock freefile If it is unclear, examine carefully all the facts in the operation of the particular business. Hrblock freefile The following example shows how a careful examination of the facts in two similar situations results in different conclusions. Hrblock freefile Example. Hrblock freefile Maple Corporation is in the business of leasing cars. Hrblock freefile At the end of their useful lives, when the cars are no longer profitable to lease, Maple sells them. Hrblock freefile Maple does not have a showroom, used car lot, or individuals to sell the cars. Hrblock freefile Instead, it sells them through wholesalers or by similar arrangements in which a dealer's profit is not intended or considered. Hrblock freefile Maple can depreciate the leased cars because the cars are not held primarily for sale to customers in the ordinary course of business, but are leased. Hrblock freefile If Maple buys cars at wholesale prices, leases them for a short time, and then sells them at retail prices or in sales in which a dealer's profit is intended, the cars are treated as inventory and are not depreciable property. Hrblock freefile In this situation, the cars are held primarily for sale to customers in the ordinary course of business. Hrblock freefile Containers. Hrblock freefile   Generally, containers for the products you sell are part of inventory and you cannot depreciate them. Hrblock freefile However, you can depreciate containers used to ship your products if they have a life longer than one year and meet the following requirements. Hrblock freefile They qualify as property used in your business. Hrblock freefile Title to the containers does not pass to the buyer. Hrblock freefile   To determine if these requirements are met, consider the following questions. Hrblock freefile Does your sales contract, sales invoice, or other type of order acknowledgment indicate whether you have retained title? Does your invoice treat the containers as separate items? Do any of your records state your basis in the containers? Property Having a Determinable Useful Life To be depreciable, your property must have a determinable useful life. Hrblock freefile This means that it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes. Hrblock freefile Property Lasting More Than One Year To be depreciable, property must have a useful life that extends substantially beyond the year you place it in service. Hrblock freefile Example. Hrblock freefile You maintain a library for use in your profession. Hrblock freefile You can depreciate it. Hrblock freefile However, if you buy technical books, journals, or information services for use in your business that have a useful life of one year or less, you cannot depreciate them. Hrblock freefile Instead, you deduct their cost as a business expense. Hrblock freefile What Property Cannot Be Depreciated? Certain property cannot be depreciated. Hrblock freefile This includes land and certain excepted property. Hrblock freefile Land You cannot depreciate the cost of land because land does not wear out, become obsolete, or get used up. Hrblock freefile The cost of land generally includes the cost of clearing, grading, planting, and landscaping. Hrblock freefile Although you cannot depreciate land, you can depreciate certain land preparation costs, such as landscaping costs, incurred in preparing land for business use. Hrblock freefile These costs must be so closely associated with other depreciable property that you can determine a life for them along with the life of the associated property. Hrblock freefile Example. Hrblock freefile You constructed a new building for use in your business and paid for grading, clearing, seeding, and planting bushes and trees. Hrblock freefile Some of the bushes and trees were planted right next to the building, while others were planted around the outer border of the lot. Hrblock freefile If you replace the building, you would have to destroy the bushes and trees right next to it. Hrblock freefile These bushes and trees are closely associated with the building, so they have a determinable useful life. Hrblock freefile Therefore, you can depreciate them. Hrblock freefile Add your other land preparation costs to the basis of your land because they have no determinable life and you cannot depreciate them. Hrblock freefile Excepted Property Even if the requirements explained in the preceding discussions are met, you cannot depreciate the following property. Hrblock freefile Property placed in service and disposed of in the same year. Hrblock freefile Determining when property is placed in service is explained later. Hrblock freefile Equipment used to build capital improvements. Hrblock freefile You must add otherwise allowable depreciation on the equipment during the period of construction to the basis of your improvements. Hrblock freefile See Uniform Capitalization Rules in Publication 551. Hrblock freefile Section 197 intangibles. Hrblock freefile You must amortize these costs. Hrblock freefile Section 197 intangibles are discussed in detail in Chapter 8 of Publication 535. Hrblock freefile Intangible property, such as certain computer software, that is not section 197 intangible property, can be depreciated if it meets certain requirements. Hrblock freefile See Intangible Property , later. Hrblock freefile Certain term interests. Hrblock freefile Certain term interests in property. Hrblock freefile   You cannot depreciate a term interest in property created or acquired after July 27, 1989, for any period during which the remainder interest is held, directly or indirectly, by a person related to you. Hrblock freefile A term interest in property means a life interest in property, an interest in property for a term of years, or an income interest in a trust. Hrblock freefile Related persons. Hrblock freefile   For a description of related persons, see Related Persons, later. Hrblock freefile For this purpose, however, treat as related persons only the relationships listed in items (1) through (10) of that discussion and substitute “50%” for “10%” each place it appears. Hrblock freefile Basis adjustments. Hrblock freefile   If you would be allowed a depreciation deduction for a term interest in property except that the holder of the remainder interest is related to you, you generally must reduce your basis in the term interest by any depreciation or amortization not allowed. Hrblock freefile   If you hold the remainder interest, you generally must increase your basis in that interest by the depreciation not allowed to the term interest holder. Hrblock freefile However, do not increase your basis for depreciation not allowed for periods during which either of the following situations applies. Hrblock freefile The term interest is held by an organization exempt from tax. Hrblock freefile The term interest is held by a nonresident alien individual or foreign corporation, and the income from the term interest is not effectively connected with the conduct of a trade or business in the United States. Hrblock freefile Exceptions. Hrblock freefile   The above rules do not apply to the holder of a term interest in property acquired by gift, bequest, or inheritance. Hrblock freefile They also do not apply to the holder of dividend rights that were separated from any stripped preferred stock if the rights were purchased after April 30, 1993, or to a person whose basis in the stock is determined by reference to the basis in the hands of the purchaser. Hrblock freefile When Does Depreciation Begin and End? You begin to depreciate your property when you place it in service for use in your trade or business or for the production of income. Hrblock freefile You stop depreciating property either when you have fully recovered your cost or other basis or when you retire it from service, whichever happens first. Hrblock freefile Placed in Service You place property in service when it is ready and available for a specific use, whether in a business activity, an income-producing activity, a tax-exempt activity, or a personal activity. Hrblock freefile Even if you are not using the property, it is in service when it is ready and available for its specific use. Hrblock freefile Example 1. Hrblock freefile Donald Steep bought a machine for his business. Hrblock freefile The machine was delivered last year. Hrblock freefile However, it was not installed and operational until this year. Hrblock freefile It is considered placed in service this year. Hrblock freefile If the machine had been ready and available for use when it was delivered, it would be considered placed in service last year even if it was not actually used until this year. Hrblock freefile Example 2. Hrblock freefile On April 6, Sue Thorn bought a house to use as residential rental property. Hrblock freefile She made several repairs and had it ready for rent on July 5. Hrblock freefile At that time, she began to advertise it for rent in the local newspaper. Hrblock freefile The house is considered placed in service in July when it was ready and available for rent. Hrblock freefile She can begin to depreciate it in July. Hrblock freefile Example 3. Hrblock freefile James Elm is a building contractor who specializes in constructing office buildings. Hrblock freefile He bought a truck last year that had to be modified to lift materials to second-story levels. Hrblock freefile The installation of the lifting equipment was completed and James accepted delivery of the modified truck on January 10 of this year. Hrblock freefile The truck was placed in service on January 10, the date it was ready and available to perform the function for which it was bought. Hrblock freefile Conversion to business use. Hrblock freefile   If you place property in service in a personal activity, you cannot claim depreciation. Hrblock freefile However, if you change the property's use to use in a business or income-producing activity, then you can begin to depreciate it at the time of the change. Hrblock freefile You place the property in service in the business or income-producing activity on the date of the change. Hrblock freefile Example. Hrblock freefile You bought a home and used it as your personal home several years before you converted it to rental property. Hrblock freefile Although its specific use was personal and no depreciation was allowable, you placed the home in service when you began using it as your home. Hrblock freefile You can begin to claim depreciation in the year you converted it to rental property because its use changed to an income-producing use at that time. Hrblock freefile Idle Property Continue to claim a deduction for depreciation on property used in your business or for the production of income even if it is temporarily idle (not in use). Hrblock freefile For example, if you stop using a machine because there is a temporary lack of a market for a product made with that machine, continue to deduct depreciation on the machine. Hrblock freefile Cost or Other Basis Fully Recovered You stop depreciating property when you have fully recovered your cost or other basis. Hrblock freefile You recover your basis when your section 179 and allowed or allowable depreciation deductions equal your cost or investment in the property. Hrblock freefile See What Is the Basis of Your Depreciable Property , later. Hrblock freefile Retired From Service You stop depreciating property when you retire it from service, even if you have not fully recovered its cost or other basis. Hrblock freefile You retire property from service when you permanently withdraw it from use in a trade or business or from use in the production of income because of any of the following events. Hrblock freefile You sell or exchange the property. Hrblock freefile You convert the property to personal use. Hrblock freefile You abandon the property. Hrblock freefile You transfer the property to a supplies or scrap account. Hrblock freefile The property is destroyed. Hrblock freefile If you included the property in a general asset account, see How Do You Use General Asset Accounts in chapter 4 for the rules that apply when you dispose of that property. Hrblock freefile What Method Can You Use To Depreciate Your Property? You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most property. Hrblock freefile MACRS is discussed in chapter 4. Hrblock freefile You cannot use MACRS to depreciate the following property. Hrblock freefile Property you placed in service before 1987. Hrblock freefile Certain property owned or used in 1986. Hrblock freefile Intangible property. Hrblock freefile Films, video tapes, and recordings. Hrblock freefile Certain corporate or partnership property acquired in a nontaxable transfer. Hrblock freefile Property you elected to exclude from MACRS. Hrblock freefile The following discussions describe the property listed above and explain what depreciation method should be used. Hrblock freefile Property You Placed in Service Before 1987 You cannot use MACRS for property you placed in service before 1987 (except property you placed in service after July 31, 1986, if MACRS was elected). Hrblock freefile Property placed in service before 1987 must be depreciated under the methods discussed in Publication 534. Hrblock freefile For a discussion of when property is placed in service, see When Does Depreciation Begin and End , earlier. Hrblock freefile Use of real property changed. Hrblock freefile   You generally must use MACRS to depreciate real property that you acquired for personal use before 1987 and changed to business or income-producing use after 1986. Hrblock freefile Improvements made after 1986. Hrblock freefile   You must treat an improvement made after 1986 to property you placed in service before 1987 as separate depreciable property. Hrblock freefile Therefore, you can depreciate that improvement as separate property under MACRS if it is the type of property that otherwise qualifies for MACRS depreciation. Hrblock freefile For more information about improvements, see How Do You Treat Repairs and Improvements , later and Additions and Improvements under Which Recovery Period Applies in chapter 4. Hrblock freefile Property Owned or Used in 1986 You may not be able to use MACRS for property you acquired and placed in service after 1986 if any of the situations described below apply. Hrblock freefile If you cannot use MACRS, the property must be depreciated under the methods discussed in Publication 534. Hrblock freefile For the following discussions, do not treat property as owned before you placed it in service. Hrblock freefile If you owned property in 1986 but did not place it in service until 1987, you do not treat it as owned in 1986. Hrblock freefile Personal property. Hrblock freefile   You cannot use MACRS for personal property (section 1245 property) in any of the following situations. Hrblock freefile You or someone related to you owned or used the property in 1986. Hrblock freefile You acquired the property from a person who owned it in 1986 and as part of the transaction the user of the property did not change. Hrblock freefile You lease the property to a person (or someone related to this person) who owned or used the property in 1986. Hrblock freefile You acquired the property in a transaction in which: The user of the property did not change, and The property was not MACRS property in the hands of the person from whom you acquired it because of (2) or (3) above. Hrblock freefile Real property. Hrblock freefile   You generally cannot use MACRS for real property (section 1250 property) in any of the following situations. Hrblock freefile You or someone related to you owned the property in 1986. Hrblock freefile You lease the property to a person who owned the property in 1986 (or someone related to that person). Hrblock freefile You acquired the property in a like-kind exchange, involuntary conversion, or repossession of property you or someone related to you owned in 1986. Hrblock freefile MACRS applies only to that part of your basis in the acquired property that represents cash paid or unlike property given up. Hrblock freefile It does not apply to the carried-over part of the basis. Hrblock freefile Exceptions. Hrblock freefile   The rules above do not apply to the following. Hrblock freefile Residential rental property or nonresidential real property. Hrblock freefile Any property if, in the first tax year it is placed in service, the deduction under the Accelerated Cost Recovery System (ACRS) is more than the deduction under MACRS using the half-year convention. Hrblock freefile For information on how to figure depreciation under ACRS, see Publication 534. Hrblock freefile Property that was MACRS property in the hands of the person from whom you acquired it because of (2) above. Hrblock freefile Related persons. Hrblock freefile   For this purpose, the following are related persons. Hrblock freefile An individual and a member of his or her family, including only a spouse, child, parent, brother, sister, half-brother, half-sister, ancestor, and lineal descendant. Hrblock freefile A corporation and an individual who directly or indirectly owns more than 10% of the value of the outstanding stock of that corporation. Hrblock freefile Two corporations that are members of the same controlled group. Hrblock freefile A trust fiduciary and a corporation if more than 10% of the value of the outstanding stock is directly or indirectly owned by or for the trust or grantor of the trust. Hrblock freefile The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. Hrblock freefile The fiduciaries of two different trusts, and the fiduciaries and beneficiaries of two different trusts, if the same person is the grantor of both trusts. Hrblock freefile A tax-exempt educational or charitable organization and any person (or, if that person is an individual, a member of that person's family) who directly or indirectly controls the organization. Hrblock freefile Two S corporations, and an S corporation and a regular corporation, if the same persons own more than 10% of the value of the outstanding stock of each corporation. Hrblock freefile A corporation and a partnership if the same persons own both of the following. Hrblock freefile More than 10% of the value of the outstanding stock of the corporation. Hrblock freefile More than 10% of the capital or profits interest in the partnership. Hrblock freefile The executor and beneficiary of any estate. Hrblock freefile A partnership and a person who directly or indirectly owns more than 10% of the capital or profits interest in the partnership. Hrblock freefile Two partnerships, if the same persons directly or indirectly own more than 10% of the capital or profits interest in each. Hrblock freefile The related person and a person who is engaged in trades or businesses under common control. Hrblock freefile See section 52(a) and 52(b) of the Internal Revenue Code. Hrblock freefile When to determine relationship. Hrblock freefile   You must determine whether you are related to another person at the time you acquire the property. Hrblock freefile   A partnership acquiring property from a terminating partnership must determine whether it is related to the terminating partnership immediately before the event causing the termination. Hrblock freefile For this rule, a terminating partnership is one that sells or exchanges, within 12 months, 50% or more of its total interest in partnership capital or profits. Hrblock freefile Constructive ownership of stock or partnership interest. Hrblock freefile   To determine whether a person directly or indirectly owns any of the outstanding stock of a corporation or an interest in a partnership, apply the following rules. Hrblock freefile Stock or a partnership interest directly or indirectly owned by or for a corporation, partnership, estate, or trust is considered owned proportionately by or for its shareholders, partners, or beneficiaries. Hrblock freefile However, for a partnership interest owned by or for a C corporation, this applies only to shareholders who directly or indirectly own 5% or more of the value of the stock of the corporation. Hrblock freefile An individual is considered to own the stock or partnership interest directly or indirectly owned by or for the individual's family. Hrblock freefile An individual who owns, except by applying rule (2), any stock in a corporation is considered to own the stock directly or indirectly owned by or for the individual's partner. Hrblock freefile For purposes of rules (1), (2), or (3), stock or a partnership interest considered to be owned by a person under rule (1) is treated as actually owned by that person. Hrblock freefile However, stock or a partnership interest considered to be owned by an individual under rule (2) or (3) is not treated as owned by that individual for reapplying either rule (2) or (3) to make another person considered to be the owner of the same stock or partnership interest. Hrblock freefile Intangible Property Generally, if you can depreciate intangible property, you usually use the straight line method of depreciation. Hrblock freefile However, you can choose to depreciate certain intangible property under the income forecast method (discussed later). Hrblock freefile You cannot depreciate intangible property that is a section 197 intangible or that otherwise does not meet all the requirements discussed earlier under What Property Can Be Depreciated. Hrblock freefile Straight Line Method This method lets you deduct the same amount of depreciation each year over the useful life of the property. Hrblock freefile To figure your deduction, first determine the adjusted basis, salvage value, and estimated useful life of your property. Hrblock freefile Subtract the salvage value, if any, from the adjusted basis. Hrblock freefile The balance is the total depreciation you can take over the useful life of the property. Hrblock freefile Divide the balance by the number of years in the useful life. Hrblock freefile This gives you your yearly depreciation deduction. Hrblock freefile Unless there is a big change in adjusted basis or useful life, this amount will stay the same throughout the time you depreciate the property. Hrblock freefile If, in the first year, you use the property for less than a full year, you must prorate your depreciation deduction for the number of months in use. Hrblock freefile Example. Hrblock freefile In April, Frank bought a patent for $5,100 that is not a section 197 intangible. Hrblock freefile He depreciates the patent under the straight line method, using a 17-year useful life and no salvage value. Hrblock freefile He divides the $5,100 basis by 17 years to get his $300 yearly depreciation deduction. Hrblock freefile He only used the patent for 9 months during the first year, so he multiplies $300 by 9/12 to get his deduction of $225 for the first year. Hrblock freefile Next year, Frank can deduct $300 for the full year. Hrblock freefile Patents and copyrights. Hrblock freefile   If you can depreciate the cost of a patent or copyright, use the straight line method over the useful life. Hrblock freefile The useful life of a patent or copyright is the lesser of the life granted to it by the government or the remaining life when you acquire it. Hrblock freefile However, if the patent or copyright becomes valueless before the end of its useful life, you can deduct in that year any of its remaining cost or other basis. Hrblock freefile Computer software. Hrblock freefile   Computer software is generally a section 197 intangible and cannot be depreciated if you acquired it in connection with the acquisition of assets constituting a business or a substantial part of a business. Hrblock freefile   However, computer software is not a section 197 intangible and can be depreciated, even if acquired in connection with the acquisition of a business, if it meets all of the following tests. Hrblock freefile It is readily available for purchase by the general public. Hrblock freefile It is subject to a nonexclusive license. Hrblock freefile It has not been substantially modified. Hrblock freefile   If the software meets the tests above, it may also qualify for the section 179 deduction and the special depreciation allowance, discussed later. Hrblock freefile If you can depreciate the cost of computer software, use the straight line method over a useful life of 36 months. Hrblock freefile    Tax-exempt use property subject to a lease. Hrblock freefile   The useful life of computer software leased under a lease agreement entered into after March 12, 2004, to a tax-exempt organization, governmental unit, or foreign person or entity (other than a partnership), cannot be less than 125% of the lease term. Hrblock freefile Certain created intangibles. Hrblock freefile   You can amortize certain intangibles created on or after December 31, 2003, over a 15-year period using the straight line method and no salvage value, even though they have a useful life that cannot be estimated with reasonable accuracy. Hrblock freefile For example, amounts paid to acquire memberships or privileges of indefinite duration, such as a trade association membership, are eligible costs. Hrblock freefile   The following are not eligible. Hrblock freefile Any intangible asset acquired from another person. Hrblock freefile Created financial interests. Hrblock freefile Any intangible asset that has a useful life that can be estimated with reasonable accuracy. Hrblock freefile Any intangible asset that has an amortization period or limited useful life that is specifically prescribed or prohibited by the Code, regulations, or other published IRS guidance. Hrblock freefile Any amount paid to facilitate an acquisition of a trade or business, a change in the capital structure of a business entity, and certain other transactions. Hrblock freefile   You must also increase the 15-year safe harbor amortization period to a 25-year period for certain intangibles related to benefits arising from the provision, production, or improvement of real property. Hrblock freefile For this purpose, real property includes property that will remain attached to the real property for an indefinite period of time, such as roads, bridges, tunnels, pavements, and pollution control facilities. Hrblock freefile Income Forecast Method You can choose to use the income forecast method instead of the straight line method to depreciate the following depreciable intangibles. Hrblock freefile Motion picture films or video tapes. Hrblock freefile Sound recordings. Hrblock freefile Copyrights. Hrblock freefile Books. Hrblock freefile Patents. Hrblock freefile Under the income forecast method, each year's depreciation deduction is equal to the cost of the property, multiplied by a fraction. Hrblock freefile The numerator of the fraction is the current year's net income from the property, and the denominator is the total income anticipated from the property through the end of the 10th taxable year following the taxable year the property is placed in service. Hrblock freefile For more information, see section 167(g) of the Internal Revenue Code. Hrblock freefile Films, video tapes, and recordings. Hrblock freefile   You cannot use MACRS for motion picture films, video tapes, and sound recordings. Hrblock freefile For this purpose, sound recordings are discs, tapes, or other phonorecordings resulting from the fixation of a series of sounds. Hrblock freefile You can depreciate this property using either the straight line method or the income forecast method. Hrblock freefile Participations and residuals. Hrblock freefile   You can include participations and residuals in the adjusted basis of the property for purposes of computing your depreciation deduction under the income forecast method. Hrblock freefile The participations and residuals must relate to income to be derived from the property before the end of the 10th taxable year after the property is placed in service. Hrblock freefile For this purpose, participations and residuals are defined as costs which by contract vary with the amount of income earned in connection with the property. Hrblock freefile   Instead of including these amounts in the adjusted basis of the property, you can deduct the costs in the taxable year that they are paid. Hrblock freefile Videocassettes. Hrblock freefile   If you are in the business of renting videocassettes, you can depreciate only those videocassettes bought for rental. Hrblock freefile If the videocassette has a useful life of one year or less, you can currently deduct the cost as a business expense. Hrblock freefile Corporate or Partnership Property Acquired in a Nontaxable Transfer MACRS does not apply to property used before 1987 and transferred after 1986 to a corporation or partnership (except property the transferor placed in service after July 31, 1986, if MACRS was elected) to the extent its basis is carried over from the property's adjusted basis in the transferor's hands. Hrblock freefile You must continue to use the same depreciation method as the transferor and figure depreciation as if the transfer had not occurred. Hrblock freefile However, if MACRS would otherwise apply, you can use it to depreciate the part of the property's basis that exceeds the carried-over basis. Hrblock freefile The nontaxable transfers covered by this rule include the following. Hrblock freefile A distribution in complete liquidation of a subsidiary. Hrblock freefile A transfer to a corporation controlled by the transferor. Hrblock freefile An exchange of property solely for corporate stock or securities in a reorganization. Hrblock freefile A contribution of property to a partnership in exchange for a partnership interest. Hrblock freefile A partnership distribution of property to a partner. Hrblock freefile Election To Exclude Property From MACRS If you can properly depreciate any property under a method not based on a term of years, such as the unit-of-production method, you can elect to exclude that property from MACRS. Hrblock freefile You make the election by reporting your depreciation for the property on line 15 in Part II of Form 4562 and attaching a statement as described in the instructions for Form 4562. Hrblock freefile You must make this election by the return due date (including extensions) for the tax year you place your property in service. Hrblock freefile However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within six months of the due date of the return (excluding extensions). Hrblock freefile Attach the election to the amended return and write “Filed pursuant to section 301. Hrblock freefile 9100-2” on the election statement. Hrblock freefile File the amended return at the same address you filed the original return. Hrblock freefile Use of standard mileage rate. Hrblock freefile   If you use the standard mileage rate to figure your tax deduction for your business automobile, you are treated as having made an election to exclude the automobile from MACRS. Hrblock freefile See Publication 463 for a discussion of the standard mileage rate. Hrblock freefile What Is the Basis of Your Depreciable Property? To figure your depreciation deduction, you must determine the basis of your property. Hrblock freefile To determine basis, you need to know the cost or other basis of your property. Hrblock freefile Cost as Basis The basis of property you buy is its cost plus amounts you paid for items such as sales tax (see Exception , below), freight charges, and installation and testing fees. Hrblock freefile The cost includes the amount you pay in cash, debt obligations, other property, or services. Hrblock freefile Exception. Hrblock freefile   You can elect to deduct state and local general sales taxes instead of state and local income taxes as an itemized deduction on Schedule A (Form 1040). Hrblock freefile If you make that choice, you cannot include those sales taxes as part of your cost basis. Hrblock freefile Assumed debt. Hrblock freefile   If you buy property and assume (or buy subject to) an existing mortgage or other debt on the property, your basis includes the amount you pay for the property plus the amount of the assumed debt. Hrblock freefile Example. Hrblock freefile You make a $20,000 down payment on property and assume the seller's mortgage of $120,000. Hrblock freefile Your total cost is $140,000, the cash you paid plus the mortgage you assumed. Hrblock freefile Settlement costs. Hrblock freefile   The basis of real property also includes certain fees and charges you pay in addition to the purchase price. Hrblock freefile These generally are shown on your settlement statement and include the following. Hrblock freefile Legal and recording fees. Hrblock freefile Abstract fees. Hrblock freefile Survey charges. Hrblock freefile Owner's title insurance. Hrblock freefile Amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions. Hrblock freefile   For fees and charges you cannot include in the basis of property, see Real Property in Publication 551. Hrblock freefile Property you construct or build. Hrblock freefile   If you construct, build, or otherwise produce property for use in your business, you may have to use the uniform capitalization rules to determine the basis of your property. Hrblock freefile For information about the uniform capitalization rules, see Publication 551 and the regulations under section 263A of the Internal Revenue Code. Hrblock freefile Other Basis Other basis usually refers to basis that is determined by the way you received the property. Hrblock freefile For example, your basis is other than cost if you acquired the property in exchange for other property, as payment for services you performed, as a gift, or as an inheritance. Hrblock freefile If you acquired property in this or some other way, see Publication 551 to determine your basis. Hrblock freefile Property changed from personal use. Hrblock freefile   If you held property for personal use and later use it in your business or income-producing activity, your depreciable basis is the lesser of the following. Hrblock freefile The fair market value (FMV) of the property on the date of the change in use. Hrblock freefile Your original cost or other basis adjusted as follows. Hrblock freefile Increased by the cost of any permanent improvements or additions and other costs that must be added to basis. Hrblock freefile Decreased by any deductions you claimed for casualty and theft losses and other items that reduced your basis. Hrblock freefile Example. Hrblock freefile Several years ago, Nia paid $160,000 to have her home built on a lot that cost her $25,000. Hrblock freefile Before changing the property to rental use last year, she paid $20,000 for permanent improvements to the house and claimed a $2,000 casualty loss deduction for damage to the house. Hrblock freefile Land is not depreciable, so she includes only the cost of the house when figuring the basis for depreciation. Hrblock freefile Nia's adjusted basis in the house when she changed its use was $178,000 ($160,000 + $20,000 − $2,000). Hrblock freefile On the same date, her property had an FMV of $180,000, of which $15,000 was for the land and $165,000 was for the house. Hrblock freefile The basis for depreciation on the house is the FMV on the date of change ($165,000), because it is less than her adjusted basis ($178,000). Hrblock freefile Property acquired in a nontaxable transaction. Hrblock freefile   Generally, if you receive property in a nontaxable exchange, the basis of the property you receive is the same as the adjusted basis of the property you gave up. Hrblock freefile Special rules apply in determining the basis and figuring the MACRS depreciation deduction and special depreciation allowance for property acquired in a like-kind exchange or involuntary conversion. Hrblock freefile See Like-kind exchanges and involuntary conversions. Hrblock freefile under How Much Can You Deduct? in chapter 3 and Figuring the Deduction for Property Acquired in a Nontaxable Exchange in chapter 4. Hrblock freefile   There are also special rules for determining the basis of MACRS property involved in a like-kind exchange or involuntary conversion when the property is contained in a general asset account. Hrblock freefile See How Do You Use General Asset Accounts in chapter 4. Hrblock freefile Adjusted Basis To find your property's basis for depreciation, you may have to make certain adjustments (increases and decreases) to the basis of the property for events occurring between the time you acquired the property and the time you placed it in service. Hrblock freefile These events could include the following. Hrblock freefile Installing utility lines. Hrblock freefile Paying legal fees for perfecting the title. Hrblock freefile Settling zoning issues. Hrblock freefile Receiving rebates. Hrblock freefile Incurring a casualty or theft loss. Hrblock freefile For a discussion of adjustments to the basis of your property, see Adjusted Basis in Publication 551. Hrblock freefile If you depreciate your property under MACRS, you also may have to reduce your basis by certain deductions and credits with respect to the property. Hrblock freefile For more information, see What Is the Basis for Depreciation in chapter 4. Hrblock freefile . Hrblock freefile Basis adjustment for depreciation allowed or allowable. Hrblock freefile   You must reduce the basis of property by the depreciation allowed or allowable, whichever is greater. Hrblock freefile Depreciation allowed is depreciation you actually deducted (from which you received a tax benefit). Hrblock freefile Depreciation allowable is depreciation you are entitled to deduct. Hrblock freefile   If you do not claim depreciation you are entitled to deduct, you must still reduce the basis of the property by the full amount of depreciation allowable. Hrblock freefile   If you deduct more depreciation than you should, you must reduce your basis by any amount deducted from which you received a tax benefit (the depreciation allowed). Hrblock freefile How Do You Treat Repairs and Improvements? If you improve depreciable property, you must treat the improvement as separate depreciable property. Hrblock freefile Improvement means an addition to or partial replacement of property that adds to its value, appreciably lengthens the time you can use it, or adapts it to a different use. Hrblock freefile You generally deduct the cost of repairing business property in the same way as any other business expense. Hrblock freefile However, if a repair or replacement increases the value of your property, makes it more useful, or lengthens its life, you must treat it as an improvement and depreciate it. Hrblock freefile Example. Hrblock freefile You repair a small section on one corner of the roof of a rental house. Hrblock freefile You deduct the cost of the repair as a rental expense. Hrblock freefile However, if you completely replace the roof, the new roof is an improvement because it increases the value and lengthens the life of the property. Hrblock freefile You depreciate the cost of the new roof. Hrblock freefile Improvements to rented property. Hrblock freefile   You can depreciate permanent improvements you make to business property you rent from someone else. Hrblock freefile Do You Have To File Form 4562? Use Form 4562 to figure your deduction for depreciation and amortization. Hrblock freefile Attach Form 4562 to your tax return for the current tax year if you are claiming any of the following items. Hrblock freefile A section 179 deduction for the current year or a section 179 carryover from a prior year. Hrblock freefile See chapter 2 for information on the section 179 deduction. Hrblock freefile Depreciation for property placed in service during the current year. Hrblock freefile Depreciation on any vehicle or other listed property, regardless of when it was placed in service. Hrblock freefile See chapter 5 for information on listed property. Hrblock freefile A deduction for any vehicle if the deduction is reported on a form other than Schedule C (Form 1040) or Schedule C-EZ (Form 1040). Hrblock freefile Amortization of costs if the current year is the first year of the amortization period. Hrblock freefile Depreciation or amortization on any asset on a corporate income tax return (other than Form 1120S, U. Hrblock freefile S. Hrblock freefile Income Tax Return for an S Corporation) regardless of when it was placed in service. Hrblock freefile You must submit a separate Form 4562 for each business or activity on your return for which a Form 4562 is required. Hrblock freefile Table 1-1 presents an overview of the purpose of the various parts of Form 4562. Hrblock freefile Employee. Hrblock freefile   Do not use Form 4562 if you are an employee and you deduct job-related vehicle expenses using either actual expenses (including depreciation) or the standard mileage rate. Hrblock freefile Instead, use either Form 2106 or Form 2106-EZ. Hrblock freefile Use Form 2106-EZ if you are claiming the standard mileage rate and you are not reimbursed by your employer for any expenses. Hrblock freefile How Do You Correct Depreciation Deductions? If you deducted an incorrect amount of depreciation in any year, you may be able to make a correction by filing an amended return for that year. Hrblock freefile See Filing an Amended Return , next. Hrblock freefile If you are not allowed to make the correction on an amended return, you may be able to change your accounting method to claim the correct amount of depreciation. Hrblock freefile See Changing Your Accounting Method , later. Hrblock freefile Filing an Amended Return You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations. Hrblock freefile You claimed the incorrect amount because of a mathematical error made in any year. Hrblock freefile You claimed the incorrect amount because of a posting error made in any year. Hrblock freefile You have not adopted a method of accounting for property placed in service by you in tax years ending after December 29, 2003. Hrblock freefile You claimed the incorrect amount on property placed in service by you in tax years ending before December 30, 2003. Hrblock freefile Adoption of accounting method defined. Hrblock freefile   Generally, you adopt a method of accounting for depreciation by using a permissible method of determining depreciation when you file your first tax return, or by using the same impermissible method of determining depreciation in two or more consecutively filed tax returns. Hrblock freefile   For an exception to this 2-year rule, see Revenue Procedure 2011-14 on page 330 of the Internal Revenue Bulletin 2011-4, available at www. Hrblock freefile irs. Hrblock freefile gov/pub/irs-irbs/irb11-04. Hrblock freefile pdf. Hrblock freefile (Note. Hrblock freefile Revenue Procedure 2011-14 is clarified and modified by Revenue Procedure 2012-20. Hrblock freefile For more information, see Revenue Procedure 2012-20 on page 700 of the Internal Revenue Bulletin 2012-14, available at www. Hrblock freefile irs. Hrblock freefile gov/pub/irs-irbs/irb12-14. Hrblock freefile pdf. Hrblock freefile )   For a safe harbor method of accounting to treat rotable spare parts as depreciable assets and procedures to obtain automatic consent to change to the safe harbor method of accounting, see Revenue Procedure 2007-48 on page 110 of Internal Revenue Bulletin 2007-29, available at www. Hrblock freefile irs. Hrblock freefile gov/pub/irs-irbs/irb07-29. Hrblock freefile pdf. Hrblock freefile When to file. Hrblock freefile   If an amended return is allowed, you must file it by the later of the following. Hrblock freefile 3 years from the date you filed your original return for the year in which you did not deduct the correct amount. Hrblock freefile A return filed before an unextended due date is considered filed on that due date. Hrblock freefile 2 years from the time you paid your tax for that year. Hrblock freefile Changing Your Accounting Method Generally, you must get IRS approval to change your method of accounting. Hrblock freefile You generally must file Form 3115, Application for Change in Accounting Method, to request a change in your method of accounting for depreciation. Hrblock freefile The following are examples of a change in method of accounting for depreciation. Hrblock freefile A change from an impermissible method of determining depreciation for depreciable property, if the impermissible method was used in two or more consecutively filed tax returns. Hrblock freefile A change in the treatment of an asset from nondepreciable to depreciable or vice versa. Hrblock freefile A change in the depreciation method, period of recovery, or convention of a depreciable asset. Hrblock freefile A change from not claiming to claiming the special depreciation allowance if you did not make the election to not claim any special allowance. Hrblock freefile A change from claiming a 50% special depreciation allowance to claiming a 30% special depreciation allowance for qualified property (including property that is included in a class of property for which you elected a 30% special allowance instead of a 50% special allowance). Hrblock freefile Changes in depreciation that are not a change in method of accounting (and may only be made on an amended return) include the following. Hrblock freefile An adjustment in the useful life of a depreciable asset for which depreciation is determined under section 167. Hrblock freefile A change in use of an asset in the hands of the same taxpayer. Hrblock freefile Making a late depreciation election or revoking a timely valid depreciation election (including the election not to deduct the special depreciation allowance). Hrblock freefile If you elected not to claim any special allowance, a change from not claiming to claiming the special allowance is a revocation of the election and is not an accounting method change. Hrblock freefile Generally, you must get IRS approval to make a late depreciation election or revoke a depreciation election. Hrblock freefile You must submit a request for a letter ruling to make a late election or revoke an election. Hrblock freefile Any change in the placed in service date of a depreciable asset. Hrblock freefile See section 1. Hrblock freefile 446-1(e)(2)(ii)(d) of the regulations for more information and examples. Hrblock freefile IRS approval. Hrblock freefile   In some instances, you may be able to get approval from the IRS to change your method of accounting for depreciation under the automatic change request procedures generally covered in Revenue Procedure 2011-14. Hrblock freefile If you do not qualify to use the automatic procedures to get approval, you must use the advance consent request procedures generally covered in Revenue Procedure 97-27, 1997-1 C. Hrblock freefile B. Hrblock freefile 680. Hrblock freefile Also see the Instructions for Form 3115 for more information on getting approval, including lists of scope limitations and automatic accounting method changes. Hrblock freefile Additional guidance. Hrblock freefile    For additional guidance and special procedures for changing your accounting method, automatic change procedures, amending your return, and filing Form 3115, see Revenue Procedure 2011-14 on page 330 of the Internal Revenue Bulletin 2011-4, available at www. Hrblock freefile irs. Hrblock freefile gov/pub/irs-irbs/irb11-04. Hrblock freefile pdf. Hrblock freefile (Note. Hrblock freefile Revenue Procedure 2011-14 is clarified and modified by Revenue Procedure 2012-20. Hrblock freefile For more information, see Revenue Procedure 2012-20 on page 700 of the Internal Revenue Bulletin 2012-14, available at www. Hrblock freefile irs. Hrblock freefile gov/pub/irs-irbs/irb12-14. Hrblock freefile pdf. Hrblock freefile )   For a safe harbor method of accounting to treat rotable spare parts as depreciable assets, see Revenue Procedure 2007-48 on page 110 of Internal Revenue Bulletin 2007-29, available at www. Hrblock freefile irs. Hrblock freefile gov/pub/irs-irbs/irb07-29. Hrblock freefile pdf. Hrblock freefile Table 1-1. Hrblock freefile Purpose of Form 4562 This table describes the purpose of the various parts of Form 4562. Hrblock freefile For more information, see Form 4562 and its instructions. Hrblock freefile Part Purpose I • Electing the section 179 deduction • Figuring the maximum section 179 deduction for the current year • Figuring any section 179 deduction carryover to the next year II • Reporting the special depreciation allowance for property (other than listed property) placed in service during the tax year • Reporting depreciation deductions on property being depreciated under any method other than Modified Accelerated Cost Recovery System (MACRS) III • Reporting MACRS depreciation deductions for property placed in service before this year • Reporting MACRS depreciation deductions for property (other than listed property) placed in service during the current year IV • Summarizing other parts V • Reporting the special depreciation allowance for automobiles and other listed property • Reporting MACRS depreciation on automobiles and other listed property • Reporting the section 179 cost elected for automobiles and other listed property • Reporting information on the use of automobiles and other transportation vehicles VI • Reporting amortization deductions Section 481(a) adjustment. Hrblock freefile   If you file Form 3115 and change from an impermissible method to a permissible method of accounting for depreciation, you can make a section 481(a) adjustment for any unclaimed or excess amount of allowable depreciation. Hrblock freefile The adjustment is the difference between the total depreciation actually deducted for the property and the total amount allowable prior to the year of change. Hrblock freefile If no depreciation was deducted, the adjustment is the total depreciation allowable prior to the year of change. Hrblock freefile A negative section 481(a) adjustment results in a decrease in taxable income. Hrblock freefile It is taken into account in the year of change and is reported on your business tax returns as “other expenses. Hrblock freefile ” A positive section 481(a) adjustment results in an increase in taxable income. Hrblock freefile It is generally taken into account over 4 tax years and is reported on your business tax returns as “other income. Hrblock freefile ” However, you can elect to use a one-year adjustment period and report the adjustment in the year of change if the total adjustment is less than $25,000. Hrblock freefile Make the election by completing the appropriate line on Form 3115. Hrblock freefile   If you file a Form 3115 and change from one permissible method to another permissible method, the section 481(a) adjustment is zero. Hrblock freefile Prev  Up  Next   Home   More Online Publications
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The Hrblock Freefile

Hrblock freefile 6. Hrblock freefile   Basis of Assets Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Cost BasisReal Property Allocating the Basis Uniform Capitalization Rules Adjusted BasisIncreases to Basis Decreases to Basis Basis Other Than CostTaxable Exchanges Involuntary Conversions Nontaxable Exchanges Property Received as a Gift Property Transferred From a Spouse Inherited Property Property Distributed From a Partnership or Corporation Introduction Your basis is the amount of your investment in property for tax purposes. Hrblock freefile Use basis to figure the gain or loss on the sale, exchange, or other disposition of property. Hrblock freefile Also use basis to figure depreciation, amortization, depletion, and casualty losses. Hrblock freefile If you use property for both business or investment purposes and for personal purposes, you must allocate the basis based on the use. Hrblock freefile Only the basis allocated to the business or investment use of the property can be depreciated. Hrblock freefile Your original basis in property is adjusted (increased or decreased) by certain events. Hrblock freefile For example, if you make improvements to the property, increase your basis. Hrblock freefile If you take deductions for depreciation, or casualty losses, or claim certain credits, reduce your basis. Hrblock freefile Keep accurate records of all items that affect the basis of your assets. Hrblock freefile For information on keeping records, see chapter 1. Hrblock freefile Topics - This chapter discusses: Cost basis Adjusted basis Basis other than cost Useful Items - You may want to see: Publication 535 Business Expenses 544 Sales and Other Dispositions of Assets 551 Basis of Assets 946 How To Depreciate Property See chapter 16 for information about getting publications and forms. Hrblock freefile Cost Basis The basis of property you buy is usually its cost. Hrblock freefile Cost is the amount you pay in cash, debt obligations, other property, or services. Hrblock freefile Your cost includes amounts you pay for sales tax, freight, installation, and testing. Hrblock freefile The basis of real estate and business assets will include other items, discussed later. Hrblock freefile Basis generally does not include interest payments. Hrblock freefile However, see Carrying charges and Capitalized interest in chapter 4 of Publication 535. Hrblock freefile You also may have to capitalize (add to basis) certain other costs related to buying or producing property. Hrblock freefile Under the uniform capitalization rules, discussed later, you may have to capitalize direct costs and certain indirect costs of producing property. Hrblock freefile Loans with low or no interest. Hrblock freefile   If you buy property on a time-payment plan that charges little or no interest, the basis of your property is your stated purchase price minus the amount considered to be unstated interest. Hrblock freefile You generally have unstated interest if your interest rate is less than the applicable federal rate. Hrblock freefile See the discussion of unstated interest in Publication 537, Installment Sales. Hrblock freefile Real Property Real property, also called real estate, is land and generally anything built on, growing on, or attached to land. Hrblock freefile If you buy real property, certain fees and other expenses you pay are part of your cost basis in the property. Hrblock freefile Some of these expenses are discussed next. Hrblock freefile Lump sum purchase. Hrblock freefile   If you buy improvements, such as buildings, and the land on which they stand for a lump sum, allocate your cost basis between the land and improvements. Hrblock freefile Allocate the cost basis according to the respective fair market values (FMVs) of the land and improvements at the time of purchase. Hrblock freefile Figure the basis of each asset by multiplying the lump sum by a fraction. Hrblock freefile The numerator is the FMV of that asset and the denominator is the FMV of the whole property at the time of purchase. Hrblock freefile Fair market value (FMV). Hrblock freefile   FMV is the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts. Hrblock freefile Sales of similar property on or about the same date may help in figuring the FMV of the property. Hrblock freefile If you are not certain of the FMV of the land and improvements, you can allocate the basis according to their assessed values for real estate tax purposes. Hrblock freefile Real estate taxes. Hrblock freefile   If you pay the real estate taxes the seller owed on real property you bought, and the seller did not reimburse you, treat those taxes as part of your basis. Hrblock freefile   If you reimburse the seller for taxes the seller paid for you, you generally can deduct that amount as a tax expense. Hrblock freefile Whether or not you reimburse the seller, do not include that amount in the basis of your property. Hrblock freefile Settlement costs. Hrblock freefile   Your basis includes the settlement fees and closing costs for buying the property. Hrblock freefile See Publication 551 for a detailed list of items you can and cannot include in basis. Hrblock freefile   Do not include fees and costs for getting a loan on the property. Hrblock freefile Also, do not include amounts placed in escrow for the future payment of items such as taxes and insurance. Hrblock freefile Points. Hrblock freefile   If you pay points to get a loan (including a mortgage, second mortgage, or line-of-credit), do not add the points to the basis of the related property. Hrblock freefile You may be able to deduct the points currently or over the term of the loan. Hrblock freefile For more information about deducting points, see Points in chapter 4 of Publication 535. Hrblock freefile Assumption of a mortgage. Hrblock freefile   If you buy property and assume (or buy the property subject to) an existing mortgage, your basis includes the amount you pay for the property plus the amount you owe on the mortgage. Hrblock freefile Example. Hrblock freefile If you buy a farm for $100,000 cash and assume a mortgage of $400,000, your basis is $500,000. Hrblock freefile Constructing assets. Hrblock freefile   If you build property or have assets built for you, your expenses for this construction are part of your basis. Hrblock freefile Some of these expenses include the following costs: Land, Labor and materials, Architect's fees, Building permit charges, Payments to contractors, Payments for rental equipment, and Inspection fees. Hrblock freefile   In addition, if you use your own employees, farm materials, and equipment to build an asset, do not deduct the following expenses. Hrblock freefile You must capitalize them (include them in the asset's basis). Hrblock freefile Employee wages paid for the construction work, reduced by any employment credits allowed. Hrblock freefile Depreciation on equipment you own while it is used in the construction. Hrblock freefile Operating and maintenance costs for equipment used in the construction. Hrblock freefile The cost of business supplies and materials used in the construction. Hrblock freefile    Do not include the value of your own labor, or any other labor you did not pay for, in the basis of any property you construct. Hrblock freefile Allocating the Basis In some instances, the rules for determining basis apply to a group of assets acquired in the same transaction or to property that consists of separate items. Hrblock freefile To determine the basis of these assets or separate items, there must be an allocation of basis. Hrblock freefile Group of assets acquired. Hrblock freefile   If you buy multiple assets for a lump sum, allocate the amount you pay among the assets. Hrblock freefile Use this allocation to figure your basis for depreciation and gain or loss on a later disposition of any of these assets. Hrblock freefile You and the seller may agree in the sales contract to a specific allocation of the purchase price among the assets. Hrblock freefile If this allocation is based on the value of each asset and you and the seller have adverse tax interests, the allocation generally will be accepted. Hrblock freefile Farming business acquired. Hrblock freefile   If you buy a group of assets that makes up a farming business, there are special rules you must use to allocate the purchase price among the assets. Hrblock freefile Generally, reduce the purchase price by any cash received. Hrblock freefile Allocate the remaining purchase price to the other business assets received in proportion to (but not more than) their FMV and in a certain order. Hrblock freefile See Trade or Business Acquired under Allocating the Basis in Publication 551 for more information. Hrblock freefile Transplanted embryo. Hrblock freefile   If you buy a cow that is pregnant with a transplanted embryo, allocate to the basis of the cow the part of the purchase price equal to the FMV of the cow without the implant. Hrblock freefile Allocate the rest of the purchase price to the basis of the calf. Hrblock freefile Neither the cost allocated to the cow nor the cost allocated to the calf is deductible as a current business expense. Hrblock freefile Uniform Capitalization Rules Under the uniform capitalization rules, you must include certain direct and indirect costs in the basis of property you produce or in your inventory costs, rather than claim them as a current deduction. Hrblock freefile You recover these costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property. Hrblock freefile Generally, you are subject to the uniform capitalization rules if you do any of the following: Produce real or tangible personal property, or Acquire property for resale. Hrblock freefile However, this rule does not apply to personal property if your average annual gross receipts for the 3-tax-year period ending with the year preceding the current tax year are $10 million or less. Hrblock freefile You produce property if you construct, build, install, manufacture, develop, improve, or create the property. Hrblock freefile You are not subject to the uniform capitalization rules if the property is produced for personal use. Hrblock freefile In a farming business, you produce property if you raise or grow any agricultural or horticultural commodity, including plants and animals. Hrblock freefile Plants. Hrblock freefile   A plant produced in a farming business includes the following items: A fruit, nut, or other crop-bearing tree; An ornamental tree; A vine; A bush; Sod; and The crop or yield of a plant that will have more than one crop or yield. Hrblock freefile Animals. Hrblock freefile   An animal produced in a farming business includes any stock, poultry or other bird, and fish or other sea life. Hrblock freefile The direct and indirect costs of producing plants or animals include preparatory costs and preproductive period costs. Hrblock freefile Preparatory costs include the acquisition costs of the seed, seedling, plant, or animal. Hrblock freefile For plants, preproductive period costs include the costs of items such as irrigation, pruning, frost protection, spraying, and harvesting. Hrblock freefile For animals, preproductive period costs include the costs of items such as feed, maintaining pasture or pen areas, breeding, veterinary services, and bedding. Hrblock freefile Exceptions. Hrblock freefile   In a farming business, the uniform capitalization rules do not apply to: Any animal, Any plant with a preproductive period of 2 years or less, or Any costs of replanting certain plants lost or damaged due to casualty. Hrblock freefile   Exceptions (1) and (2) do not apply to a corporation, partnership, or tax shelter required to use an accrual method of accounting. Hrblock freefile See Accrual Method Required under Accounting Methods in chapter 2. Hrblock freefile   In addition, you can elect not to use the uniform capitalization rules for plants with a preproductive period of more than 2 years. Hrblock freefile If you make this election, special rules apply. Hrblock freefile This election cannot be made by a corporation, partnership, or tax shelter required to use an accrual method of accounting. Hrblock freefile This election also does not apply to any costs incurred for the planting, cultivation, maintenance, or development of any citrus or almond grove (or any part thereof) within the first 4 years the trees were planted. Hrblock freefile    If you elect not to use the uniform capitalization rules, you must use the alternative depreciation system for all property used in any of your farming businesses and placed in service in any tax year during which the election is in effect. Hrblock freefile See chapter 7, for additional information on depreciation. Hrblock freefile Example. Hrblock freefile You grow trees that have a preproductive period of more than 2 years. Hrblock freefile The trees produce an annual crop. Hrblock freefile You are an individual and the uniform capitalization rules apply to your farming business. Hrblock freefile You must capitalize the direct costs and an allocable part of indirect costs incurred due to the production of the trees. Hrblock freefile You are not required to capitalize the costs of producing the annual crop because its preproductive period is 2 years or less. Hrblock freefile Preproductive period of more than 2 years. Hrblock freefile   The preproductive period of plants grown in commercial quantities in the United States is based on their nationwide weighted average preproductive period. Hrblock freefile Plants producing the crops or yields shown in Table 6-1 have a nationwide weighted average preproductive period of more than 2 years. Hrblock freefile Other plants (not shown in Table 6-1) may also have a nationwide weighted average preproductive period of more than 2 years. Hrblock freefile More information. Hrblock freefile   For more information on the uniform capitalization rules that apply to property produced in a farming business, see Regulations section 1. Hrblock freefile 263A-4. Hrblock freefile Table 6-1. Hrblock freefile Plants With a Preproductive Period of More Than 2 Years Plants producing the following crops or yields have a nationwide weighted average preproductive period of more than 2 years. Hrblock freefile Almonds Apples Apricots Avocados Blueberries Cherries Chestnuts Coffee beans Currants Dates Figs Grapefruit Grapes Guavas Kiwifruit Kumquats Lemons Limes Macadamia nuts Mangoes Nectarines Olives Oranges Peaches Pears Pecans Persimmons Pistachio nuts Plums Pomegranates Prunes Tangelos Tangerines Tangors Walnuts Adjusted Basis Before figuring gain or loss on a sale, exchange, or other disposition of property or figuring allowable depreciation, depletion, or amortization, you must usually make certain adjustments to the cost basis or basis other than cost (discussed later) of the property. Hrblock freefile The adjustments to the original basis are increases or decreases to the cost basis or other basis which result in the adjusted basis of the property. Hrblock freefile Increases to Basis Increase the basis of any property by all items properly added to a capital account. Hrblock freefile These include the cost of any improvements having a useful life of more than 1 year. Hrblock freefile The following costs increase the basis of property. Hrblock freefile The cost of extending utility service lines to property. Hrblock freefile Legal fees, such as the cost of defending and perfecting title. Hrblock freefile Legal fees for seeking a decrease in an assessment levied against property to pay for local improvements. Hrblock freefile Assessments for items such as paving roads and building ditches that increase the value of the property assessed. Hrblock freefile Do not deduct these expenses as taxes. Hrblock freefile However, you can deduct as taxes amounts assessed for maintenance or repairs, or for meeting interest charges related to the improvements. Hrblock freefile If you make additions or improvements to business property, depreciate the basis of each addition or improvement as separate depreciable property using the rules that would apply to the original property if you had placed it in service at the same time you placed the addition or improvement in service. Hrblock freefile See chapter 7. Hrblock freefile Deducting vs. Hrblock freefile capitalizing costs. Hrblock freefile   Do not add to your basis costs you can deduct as current expenses. Hrblock freefile For example, amounts paid for incidental repairs or maintenance are deductible as business expenses and are not added to basis. Hrblock freefile However, you can elect either to deduct or to capitalize certain other costs. Hrblock freefile See chapter 7 in Publication 535. Hrblock freefile Decreases to Basis The following are some items that reduce the basis of property. Hrblock freefile Section 179 deduction. Hrblock freefile Deductions previously allowed or allowable for amortization, depreciation, and depletion. Hrblock freefile Alternative motor vehicle credit. Hrblock freefile See Form 8910. Hrblock freefile Alternative fuel vehicle refueling property credit. Hrblock freefile See Form 8911. Hrblock freefile Residential energy efficient property credits. Hrblock freefile See Form 5695. Hrblock freefile Investment credit (part or all) taken. Hrblock freefile Casualty and theft losses and insurance reimbursements. Hrblock freefile Payments you receive for granting an easement. Hrblock freefile Exclusion from income of subsidies for energy conservation measures. Hrblock freefile Certain canceled debt excluded from income. Hrblock freefile Rebates from a manufacturer or seller. Hrblock freefile Patronage dividends received from a cooperative association as a result of a purchase of property. Hrblock freefile See Patronage Dividends in chapter 3. Hrblock freefile Gas-guzzler tax. Hrblock freefile See Form 6197. Hrblock freefile Some of these items are discussed next. Hrblock freefile For a more detailed list of items that decrease basis, see section 1016 of the Internal Revenue Code and Publication 551. Hrblock freefile Depreciation and section 179 deduction. Hrblock freefile   The adjustments you must make to the basis of the property if you take the section 179 deduction or depreciate the property are explained next. Hrblock freefile For more information on these deductions, see chapter 7. Hrblock freefile Section 179 deduction. Hrblock freefile   If you take the section 179 expense deduction for all or part of the cost of qualifying business property, decrease the basis of the property by the deduction. Hrblock freefile Depreciation. Hrblock freefile   Decrease the basis of property by the depreciation you deducted or could have deducted on your tax returns under the method of depreciation you chose. Hrblock freefile If you took less depreciation than you could have under the method chosen, decrease the basis by the amount you could have taken under that method. Hrblock freefile If you did not take a depreciation deduction, reduce the basis by the full amount of the depreciation you could have taken. Hrblock freefile   If you deducted more depreciation than you should have, decrease your basis by the amount you should have deducted plus the part of the excess depreciation you deducted that actually reduced your tax liability for any year. Hrblock freefile   See chapter 7 for information on figuring the depreciation you should have claimed. Hrblock freefile   In decreasing your basis for depreciation, take into account the amount deducted on your tax returns as depreciation and any depreciation you must capitalize under the uniform capitalization rules. Hrblock freefile Casualty and theft losses. Hrblock freefile   If you have a casualty or theft loss, decrease the basis of the property by any insurance or other reimbursement. Hrblock freefile Also, decrease it by any deductible loss not covered by insurance. Hrblock freefile See chapter 11 for information about figuring your casualty or theft loss. Hrblock freefile   You must increase your basis in the property by the amount you spend on clean-up costs (such as debris removal) and repairs that restore the property to its pre-casualty condition. Hrblock freefile To make this determination, compare the repaired property to the property before the casualty. Hrblock freefile Easements. Hrblock freefile   The amount you receive for granting an easement is usually considered to be proceeds from the sale of an interest in the real property. Hrblock freefile It reduces the basis of the affected part of the property. Hrblock freefile If the amount received is more than the basis of the part of the property affected by the easement, reduce your basis in that part to zero and treat the excess as a recognized gain. Hrblock freefile See Easements and rights-of-way in chapter 3. Hrblock freefile Exclusion from income of subsidies for energy conservation measures. Hrblock freefile   You can exclude from gross income any subsidy you received from a public utility company for the purchase or installation of an energy conservation measure for a dwelling unit. Hrblock freefile Reduce the basis of the property by the excluded amount. Hrblock freefile Canceled debt excluded from income. Hrblock freefile   If a debt you owe is canceled or forgiven, other than as a gift or bequest, you generally must include the canceled amount in your gross income for tax purposes. Hrblock freefile A debt includes any indebtedness for which you are liable or which attaches to property you hold. Hrblock freefile   You can exclude your canceled debt from income if the debt is any of the following. Hrblock freefile Debt canceled in a bankruptcy case or when you are insolvent. Hrblock freefile Qualified farm debt. Hrblock freefile Qualified real property business debt (provided you are not a C corporation). Hrblock freefile Qualified principal residence indebtedness. Hrblock freefile Discharge of certain indebtedness of a qualified individual because of Midwestern disasters. Hrblock freefile If you exclude canceled debt described in (1) or (2), you may have to reduce the basis of your depreciable and nondepreciable property. Hrblock freefile If you exclude canceled debt described in (3), you must only reduce the basis of your depreciable property by the excluded amount. Hrblock freefile   For more information about canceled debt in a bankruptcy case, see Publication 908, Bankruptcy Tax Guide. Hrblock freefile For more information about insolvency and canceled debt that is qualified farm debt or qualified principal residence indebtedness, see chapter 3. Hrblock freefile For more information about qualified real property business debt, see Publication 334, Tax Guide for Small Business. Hrblock freefile For more information about canceled debt in Midwestern disaster areas, see Publication 4492-B, Information for Affected Taxpayers in the Midwestern Disaster Areas. Hrblock freefile Basis Other Than Cost There are times when you cannot use cost as basis. Hrblock freefile In these situations, the fair market value or the adjusted basis of property may be used. Hrblock freefile Examples are discussed next. Hrblock freefile Property changed from personal to business or rental use. Hrblock freefile   When you hold property for personal use and then change it to business use or use it to produce rent, you must figure its basis for depreciation. Hrblock freefile An example of changing property from personal to business use would be changing the use of your pickup truck that you originally purchased for your personal use to use in your farming business. Hrblock freefile   The basis for depreciation is the lesser of: The FMV of the property on the date of the change, or Your adjusted basis on the date of the change. Hrblock freefile   If you later sell or dispose of this property, the basis you use will depend on whether you are figuring a gain or loss. Hrblock freefile The basis for figuring a gain is your adjusted basis in the property when you sell the property. Hrblock freefile Figure the basis for a loss starting with the smaller of your adjusted basis or the FMV of the property at the time of the change to business or rental use. Hrblock freefile Then make adjustments (increases and decreases) for the period after the change in the property's use, as discussed earlier under Adjusted Basis . Hrblock freefile Property received for services. Hrblock freefile   If you receive property for services, include the property's FMV in income. Hrblock freefile The amount you include in income becomes your basis. Hrblock freefile If the services were performed for a price agreed on beforehand, it will be accepted as the FMV of the property if there is no evidence to the contrary. Hrblock freefile Example. Hrblock freefile George Smith is an accountant and also operates a farming business. Hrblock freefile George agreed to do some accounting work for his neighbor in exchange for a dairy cow. Hrblock freefile The accounting work and the cow are each worth $1,500. Hrblock freefile George must include $1,500 in income for his accounting services. Hrblock freefile George's basis in the cow is $1,500. Hrblock freefile Taxable Exchanges A taxable exchange is one in which the gain is taxable, or the loss is deductible. Hrblock freefile A taxable gain or deductible loss also is known as a recognized gain or loss. Hrblock freefile A taxable exchange occurs when you receive cash or get property that is not similar or related in use to the property exchanged. Hrblock freefile If you receive property in exchange for other property in a taxable exchange, the basis of the property you receive is usually its FMV at the time of the exchange. Hrblock freefile Example. Hrblock freefile You trade a tract of farmland with an adjusted basis of $2,000 for a tractor that has an FMV of $6,000. Hrblock freefile You must report a taxable gain of $4,000 for the land. Hrblock freefile The tractor has a basis of $6,000. Hrblock freefile Involuntary Conversions If you receive property as a result of an involuntary conversion, such as a casualty, theft, or condemnation, figure the basis of the replacement property you receive using the basis of the converted property. Hrblock freefile Similar or related property. Hrblock freefile   If the replacement property is similar or related in service or use to the converted property, the replacement property's basis is the same as the old property's basis on the date of the conversion. Hrblock freefile However, make the following adjustments. Hrblock freefile Decrease the basis by the following amounts. Hrblock freefile Any loss you recognize on the involuntary conversion. Hrblock freefile Any money you receive that you do not spend on similar property. Hrblock freefile Increase the basis by the following amounts. Hrblock freefile Any gain you recognize on the involuntary conversion. Hrblock freefile Any cost of acquiring the replacement property. Hrblock freefile Money or property not similar or related. Hrblock freefile   If you receive money or property not similar or related in service or use to the converted property and you buy replacement property similar or related in service or use to the converted property, the basis of the replacement property is its cost decreased by the gain not recognized on the involuntary conversion. Hrblock freefile Allocating the basis. Hrblock freefile   If you buy more than one piece of replacement property, allocate your basis among the properties based on their respective costs. Hrblock freefile Basis for depreciation. Hrblock freefile   Special rules apply in determining and depreciating the basis of MACRS property acquired in an involuntary conversion. Hrblock freefile For information, see Figuring the Deduction for Property Acquired in a Nontaxable Exchange under Figuring Depreciation Under MACRS in chapter 7. Hrblock freefile For more information about involuntary conversions, see chapter 11. Hrblock freefile Nontaxable Exchanges A nontaxable exchange is an exchange in which you are not taxed on any gain and you cannot deduct any loss. Hrblock freefile A nontaxable gain or loss also is known as an unrecognized gain or loss. Hrblock freefile If you receive property in a nontaxable exchange, its basis is usually the same as the basis of the property you transferred. Hrblock freefile Like-Kind Exchanges The exchange of property for the same kind of property is the most common type of nontaxable exchange. Hrblock freefile For an exchange to qualify as a like-kind exchange, you must hold for business or investment purposes both the property you transfer and the property you receive. Hrblock freefile There must also be an exchange of like-kind property. Hrblock freefile For more information, see Like-Kind Exchanges in  chapter 8. Hrblock freefile The basis of the property you receive generally is the same as the adjusted basis of the property you gave up. Hrblock freefile Example 1. Hrblock freefile You traded a truck you used in your farming business for a new smaller truck to use in farming. Hrblock freefile The adjusted basis of the old truck was $10,000. Hrblock freefile The FMV of the new truck is $30,000. Hrblock freefile Because this is a nontaxable exchange, you do not recognize any gain, and your basis in the new truck is $10,000, the same as the adjusted basis of the truck you traded. Hrblock freefile Example 2. Hrblock freefile You trade a field cultivator (adjusted basis of $8,000) for a planter (FMV of $9,000). Hrblock freefile You use both the field cultivator and the planter in your farming business. Hrblock freefile The basis of the planter you receive is $8,000, the same as the field cultivator traded Exchange expenses. Hrblock freefile   Exchange expenses generally are the closing costs that you pay. Hrblock freefile They include such items as brokerage commissions, attorney fees, and deed preparation fees. Hrblock freefile Add them to the basis of the like-kind property you receive. Hrblock freefile Property plus cash. Hrblock freefile   If you trade property in a like-kind exchange and also pay money, the basis of the property you receive is the adjusted basis of the property you gave up plus the money you paid. Hrblock freefile Example. Hrblock freefile You trade in a truck (adjusted basis of $3,000) for another truck (FMV of $7,500) and pay $4,000. Hrblock freefile Your basis in the new truck is $7,000 (the $3,000 adjusted basis of the old truck plus the $4,000 cash). Hrblock freefile Special rules for related persons. Hrblock freefile   If a like-kind exchange takes place directly or indirectly between related persons and either party disposes of the property within 2 years after the exchange, the exchange no longer qualifies for like-kind exchange treatment. Hrblock freefile Each person must report any gain or loss not recognized on the original exchange unless the loss is not deductible under the related party rules. Hrblock freefile Each person reports it on the tax return filed for the year in which the later disposition occurred. Hrblock freefile If this rule applies, the basis of the property received in the original exchange will be its FMV. Hrblock freefile For more information, see chapter 8. Hrblock freefile Exchange of business property. Hrblock freefile   Exchanging the property of one business for the property of another business generally is a multiple property exchange. Hrblock freefile For information on figuring basis, see Multiple Property Exchanges in chapter 1 of Publication 544. Hrblock freefile Basis for depreciation. Hrblock freefile   Special rules apply in determining and depreciating the basis of MACRS property acquired in a like-kind transaction. Hrblock freefile For information, see Figuring the Deduction for Property Acquired in a Nontaxable Exchange under Figuring Depreciation Under MACRS in chapter 7. Hrblock freefile Partially Nontaxable Exchanges A partially nontaxable exchange is an exchange in which you receive unlike property or money in addition to like-kind property. Hrblock freefile The basis of the property you receive is the same as the adjusted basis of the property you gave up with the following adjustments. Hrblock freefile Decrease the basis by the following amounts. Hrblock freefile Any money you receive. Hrblock freefile Any loss you recognize on the exchange. Hrblock freefile Increase the basis by the following amounts. Hrblock freefile Any additional costs you incur. Hrblock freefile Any gain you recognize on the exchange. Hrblock freefile If the other party to the exchange assumes your liabilities, treat the debt assumption as money you received in the exchange. Hrblock freefile Example 1. Hrblock freefile You trade farmland (basis of $100,000) for another tract of farmland (FMV of $110,000) and $30,000 cash. Hrblock freefile You realize a gain of $40,000. Hrblock freefile This is the FMV of the land received plus the cash minus the basis of the land you traded ($110,000 + $30,000 − $100,000). Hrblock freefile Include your gain in income (recognize gain) only to the extent of the cash received. Hrblock freefile Your basis in the land you received is figured as follows. Hrblock freefile Basis of land traded $100,000 Minus: Cash received (adjustment 1(a)) − 30,000   $70,000 Plus: Gain recognized (adjustment 2(b)) + 30,000 Basis of land received $100,000 Example 2. Hrblock freefile You trade a truck (adjusted basis of $22,750) for another truck (FMV of $20,000) and $10,000 cash. Hrblock freefile You realize a gain of $7,250. Hrblock freefile This is the FMV of the truck received plus the cash minus the adjusted basis of the truck you traded ($20,000 + $10,000 − $22,750). Hrblock freefile You include all the gain in your income (recognize gain) because the gain is less than the cash you received. Hrblock freefile Your basis in the truck you received is figured as follows. Hrblock freefile Adjusted basis of truck traded $22,750 Minus: Cash received (adjustment 1(a)) −10,000   $12,750 Plus: Gain recognized (adjustment 2(b)) + 7,250 Basis of truck received $20,000 Allocation of basis. Hrblock freefile   If you receive like-kind and unlike properties in the exchange, allocate the basis first to the unlike property, other than money, up to its FMV on the date of the exchange. Hrblock freefile The rest is the basis of the like-kind property. Hrblock freefile Example. Hrblock freefile You traded a tractor with an adjusted basis of $15,000 for another tractor that had an FMV of $12,500. Hrblock freefile You also received $1,000 cash and a truck that had an FMV of $3,000. Hrblock freefile The truck is unlike property. Hrblock freefile You realized a gain of $1,500. Hrblock freefile This is the FMV of the tractor received plus the FMV of the truck received plus the cash minus the adjusted basis of the tractor you traded ($12,500 + $3,000 + $1,000 − $15,000). Hrblock freefile You include in income (recognize) all $1,500 of the gain because it is less than the FMV of the unlike property plus the cash received. Hrblock freefile Your basis in the properties you received is figured as follows. Hrblock freefile Adjusted basis of old tractor $15,000 Minus: Cash received (adjustment 1(a)) − 1,000   $14,000 Plus: Gain recognized (adjustment 2(b)) + 1,500 Total basis of properties received $15,500 Allocate the total basis of $15,500 first to the unlike property—the truck ($3,000). Hrblock freefile This is the truck's FMV. Hrblock freefile The rest ($12,500) is the basis of the tractor. Hrblock freefile Sale and Purchase If you sell property and buy similar property in two mutually dependent transactions, you may have to treat the sale and purchase as a single nontaxable exchange. Hrblock freefile Example. Hrblock freefile You used a tractor on your farm for 3 years. Hrblock freefile Its adjusted basis is $22,000 and its FMV is $40,000. Hrblock freefile You are interested in a new tractor, which sells for $60,000. Hrblock freefile Ordinarily, you would trade your old tractor for the new one and pay the dealer $20,000. Hrblock freefile Your basis for depreciating the new tractor would then be $42,000 ($20,000 + $22,000, the adjusted basis of your old tractor). Hrblock freefile However, you want a higher basis for depreciating the new tractor, so you agree to pay the dealer $60,000 for the new tractor if he will pay you $40,000 for your old tractor. Hrblock freefile Because the two transactions are dependent on each other, you are treated as having exchanged your old tractor for the new one and paid $20,000 ($60,000 − $40,000). Hrblock freefile Your basis for depreciating the new tractor is $42,000, the same as if you traded the old tractor. Hrblock freefile Property Received as a Gift To figure the basis of property you receive as a gift, you must know its adjusted basis (defined earlier) to the donor just before it was given to you. Hrblock freefile You also must know its FMV at the time it was given to you and any gift tax paid on it. Hrblock freefile FMV equal to or greater than donor's adjusted basis. Hrblock freefile   If the FMV of the property is equal to or greater than the donor's adjusted basis, your basis is the donor's adjusted basis when you received the gift. Hrblock freefile Increase your basis by all or part of any gift tax paid, depending on the date of the gift. Hrblock freefile   Also, for figuring gain or loss from a sale or other disposition of the property, or for figuring depreciation, depletion, or amortization deductions on business property, you must increase or decrease your basis (the donor's adjusted basis) by any required adjustments to basis while you held the property. Hrblock freefile See Adjusted Basis , earlier. Hrblock freefile   If you received a gift during the tax year, increase your basis in the gift (the donor's adjusted basis) by the part of the gift tax paid on it due to the net increase in value of the gift. Hrblock freefile Figure the increase by multiplying the gift tax paid by the following fraction. Hrblock freefile Net increase in value of the gift Amount of the gift   The net increase in value of the gift is the FMV of the gift minus the donor's adjusted basis. Hrblock freefile The amount of the gift is its value for gift tax purposes after reduction by any annual exclusion and marital or charitable deduction that applies to the gift. Hrblock freefile Example. Hrblock freefile In 2013, you received a gift of property from your mother that had an FMV of $50,000. Hrblock freefile Her adjusted basis was $20,000. Hrblock freefile The amount of the gift for gift tax purposes was $36,000 ($50,000 minus the $14,000 annual exclusion). Hrblock freefile She paid a gift tax of $7,320. Hrblock freefile Your basis, $26,076, is figured as follows. Hrblock freefile Fair market value $50,000 Minus: Adjusted basis −20,000 Net increase in value $30,000 Gift tax paid $7,320 Multiplied by ($30,000 ÷ $36,000) × . Hrblock freefile 83 Gift tax due to net increase in value $6,076 Adjusted basis of property to your mother +20,000 Your basis in the property $26,076 Note. Hrblock freefile If you received a gift before 1977, your basis in the gift (the donor's adjusted basis) includes any gift tax paid on it. Hrblock freefile However, your basis cannot exceed the FMV of the gift when it was given to you. Hrblock freefile FMV less than donor's adjusted basis. Hrblock freefile   If the FMV of the property at the time of the gift is less than the donor's adjusted basis, your basis depends on whether you have a gain or a loss when you dispose of the property. Hrblock freefile Your basis for figuring gain is the donor's adjusted basis plus or minus any required adjustments to basis while you held the property. Hrblock freefile Your basis for figuring loss is its FMV when you received the gift plus or minus any required adjustments to basis while you held the property. Hrblock freefile (See Adjusted Basis , earlier. Hrblock freefile )   If you use the donor's adjusted basis for figuring a gain and get a loss, and then use the FMV for figuring a loss and get a gain, you have neither gain nor loss on the sale or other disposition of the property. Hrblock freefile Example. Hrblock freefile You received farmland as a gift from your parents when they retired from farming. Hrblock freefile At the time of the gift, the land had an FMV of $80,000. Hrblock freefile Your parents' adjusted basis was $100,000. Hrblock freefile After you received the land, no events occurred that would increase or decrease your basis. Hrblock freefile If you sell the land for $120,000, you will have a $20,000 gain because you must use the donor's adjusted basis at the time of the gift ($100,000) as your basis to figure a gain. Hrblock freefile If you sell the land for $70,000, you will have a $10,000 loss because you must use the FMV at the time of the gift ($80,000) as your basis to figure a loss. Hrblock freefile If the sales price is between $80,000 and $100,000, you have neither gain nor loss. Hrblock freefile For instance, if the sales price was $90,000 and you tried to figure a gain using the donor's adjusted basis ($100,000), you would get a $10,000 loss. Hrblock freefile If you then tried to figure a loss using the FMV ($80,000), you would get a $10,000 gain. Hrblock freefile Business property. Hrblock freefile   If you hold the gift as business property, your basis for figuring any depreciation, depletion, or amortization deductions is the same as the donor's adjusted basis plus or minus any required adjustments to basis while you hold the property. Hrblock freefile Property Transferred From a Spouse The basis of property transferred to you or transferred in trust for your benefit by your spouse is the same as your spouse's adjusted basis. Hrblock freefile The same rule applies to a transfer by your former spouse if the transfer is incident to divorce. Hrblock freefile However, for property transferred in trust, adjust your basis for any gain recognized by your spouse or former spouse if the liabilities assumed plus the liabilities to which the property is subject are more than the adjusted basis of the property transferred. Hrblock freefile The transferor must give you the records needed to determine the adjusted basis and holding period of the property as of the date of the transfer. Hrblock freefile For more information, see Property Settlements in Publication 504, Divorced or Separated Individuals. Hrblock freefile Inherited Property Your basis in property you inherited from a decedent, who died before January 1, 2010, or after December 31, 2010, is generally one of the following: The FMV of the property at the date of the decedent's death. Hrblock freefile If a federal estate return is filed, you can use its appraised value. Hrblock freefile The FMV on the alternate valuation date, if the personal representative for the estate elects to use alternate valuation. Hrblock freefile For information on the alternate valuation, see the Instructions for Form 706. Hrblock freefile The decedent's adjusted basis in land to the extent of the value that is excluded from the decedent's taxable estate as a qualified conservation easement. Hrblock freefile If a federal estate tax return does not have to be filed, your basis in the inherited property is its appraised value at the date of death for state inheritance or transmission taxes. Hrblock freefile Special-use valuation method. Hrblock freefile   Under certain conditions, when a person dies, the executor or personal representative of that person's estate may elect to value qualified real property at other than its FMV. Hrblock freefile If so, the executor or personal representative values the qualified real property based on its use as a farm or other closely held business. Hrblock freefile If the executor or personal representative elects this method of valuation for estate tax purposes, this value is the basis of the property for the qualified heirs. Hrblock freefile The qualified heirs should be able to get the necessary value from the executor or personal representative of the estate. Hrblock freefile   If you are a qualified heir who received special-use valuation property, increase your basis by any gain recognized by the estate or trust because of post-death appreciation. Hrblock freefile Post-death appreciation is the property's FMV on the date of distribution minus the property's FMV either on the date of the individual's death or on the alternate valuation date. Hrblock freefile Figure all FMVs without regard to the special-use valuation. Hrblock freefile   You may be liable for an additional estate tax if, within 10 years after the death of the decedent, you transfer the property or the property stops being used as a farm. Hrblock freefile This tax does not apply if you dispose of the property in a like-kind exchange or in an involuntary conversion in which all of the proceeds are reinvested in qualified replacement property. Hrblock freefile The tax also does not apply if you transfer the property to a member of your family and certain requirements are met. Hrblock freefile   You can elect to increase your basis in special-use valuation property if it becomes subject to the additional estate tax. Hrblock freefile To increase your basis, you must make an irrevocable election and pay interest on the additional estate tax figured from the date 9 months after the decedent's death until the date of payment of the additional estate tax. Hrblock freefile If you meet these requirements, increase your basis in the property to its FMV on the date of the decedent's death or the alternate valuation date. Hrblock freefile The increase in your basis is considered to have occurred immediately before the event that resulted in the additional estate tax. Hrblock freefile   You make the election by filing, with Form 706-A, United States Additional Estate Tax Return, a statement that: Contains your (and the estate's) name, address, and taxpayer identification number; Identifies the election as an election under section 1016(c) of the Internal Revenue Code; Specifies the property for which you are making the election; and Provides any additional information required by the Form 706-A instructions. Hrblock freefile   For more information, see Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, Form 706-A, and the related instructions. Hrblock freefile Property inherited from a decedent who died in 2010. Hrblock freefile   If you inherited property from a decedent who died in 2010, different rules may apply. Hrblock freefile See Publication 4895, Tax Treatment of Property Acquired From a Decendent Dying in 2010, for details. Hrblock freefile Property Distributed From a Partnership or Corporation The following rules apply to determine a partner's basis and a shareholder's basis in property distributed respectively from a partnership to the partner with respect to the partner's interest in the partnership and from a corporation to the shareholder with respect to the shareholder's ownership of stock in the corporation. Hrblock freefile Partner's basis. Hrblock freefile   Unless there is a complete liquidation of a partner's interest, the basis of property (other than money) distributed by a partnership to the partner is its adjusted basis to the partnership immediately before the distribution. Hrblock freefile However, the basis of the property to the partner cannot be more than the adjusted basis of his or her interest in the partnership reduced by any money received in the same transaction. Hrblock freefile For more information, see Partner's Basis for Distributed Property in Publication 541, Partnerships. Hrblock freefile Shareholder's basis. Hrblock freefile   The basis of property distributed by a corporation to a shareholder is its fair market value. Hrblock freefile For more information about corporate distributions, see Distributions to Shareholders in Publication 542, Corporations. Hrblock freefile Prev  Up  Next   Home   More Online Publications