From an income tax perspective, it is generally in your best interest
to have a high cost basis, while it is in the governments interest that your
cost basis be low (lower cost basis results in a larger capital gain).
Non recurring closing costs are usually additions to basis (save that closing statement)
as are improvements to the property.
Depreciation ("theoretical" and used for investment property and not
personal use property) reduces the cost basis. Annual deductions for
depreciation you take over the holding period of a property lower the
cost basis and the result is that your are taxed on that amount (as well as
any appreciation) upon sale of the property.
Example: You purchase an asset for $100,000.00. You must first "recapture"
(pay taxes on) the depreciation previously taken at regular tax rates. Only the
amount of proceeds above the original purchase price is treated as capital gain, at the lower rate.
You depreciate it $2,500.00 per year for 10 years. Your cost basis is reduced by $25,000.00
($2,500.00 X 10 years) and is now $75,000.00. If you sell the property
for what you paid for it, $100,000.00, IRS says you have a capital gain
of $25,000.00 and must pay tax on the $25,000.00.
Other Aspects of Cost Basis:
A. RE: A & B-cost basis of a gift is the donor’s cost basis, unless he gave
it at death, in which case the basis is stepped up or down to Fair Market Value
B. Basis upon inheritance is the fair market value at death. (It may be
better, from a tax perspective, to will your property to your heirs
rather than give it to them prior to your death…after you examine the
annual and lifetime gift tax exclusion) Seek the advice of an attorney.
C. Basis for an asset purchased as "community property" in community
property states allows a totally new basis for the survivor equal to the
fair market value at the date of death (that is, both the interest of
the decedent and the interest of the survivor are "stepped up"). This
causes the entire appreciation to the date of death to be free of income
taxes if the property is sold at the death of the first spouse. Any
appreciation or depreciation after the death of the first spouse would
be taxed upon sale unless the asset passes to heirs at the death of the
second spouse, and then there is again an "elevated basis." Missouri
is not a community property state.
D. Joint Tenancy - Carries the "right of survivorship and normally, only
the interest of the decedent has a new or "Stepped up" basis. Thus, when
property is owned with one’s spouse as a Joint Tenant, the basis after
death to the survivor will be one half (1/2) of the original cost (as to
the survivor’s portion) and one half (1/2) of the value at death (as to
the portion received from the decedent). This could mean that only one
half (1/2) of the appreciation to the date of death is free of income
tax to the surviving spouse.
The manner of taking title may have significant legal and tax
consequences therefore give this matter serious consideration.
Printed with permission of: Saul Klein, CFP (CA); Edited by Lisa Bushur, CPA (MO)
Lisa Bushur, CPA
174 Clarkson Rd, Ste 100, Ellisville, MO 63011
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