If you own a business, your assets may include office equipment, real estate, inventory, stocks and bonds, and intellectual property like copyrights and patents. Over time, their value can go up or down. When you sell any of them (or even your entire business), you want to know what their tax basis is, as that amount can determine whether you owe taxes on the sale or realize a loss you can use to offset other taxes.
Tax Basis Defined
A tax basis includes the original price of an asset as well as any costs related to acquisition, such as taxes and shipping. Reinvested dividends or capital improvements increase the tax basis, while annual depreciation claimed on your tax return decreases it. The tax basis of an investment can also be changed by mergers and bankruptcies, while stock splits reduce the basis of individual shares but not the overall investment basis.
It’s important to keep track of when you acquired the asset and your capital gains tax rate. Generally speaking, investment assets held for more than one year are subject to long-term capital gains tax, which can vary depending on business and asset type. Short-term capital gains (when an asset is held for less than 1 year from date of purchase to sale) are taxed as ordinary income, and not capital gains, and must be reported separately using IRS forms 8949 and 1049-D. You want to avoid short-term capital gains at all costs.
Tax Basis for Common Business Assets
An asset’s original tax basis is often determined by how it was acquired. Assets bought, inherited, or received as a gift have different tax bases. For example:
- With gifts, the tax basis will depend on whether you sell it as a profit or loss. If you make a profit, the tax basis is the cost basis of the previous owner. If you take a loss, it is the lower of either the previous owner’s cost basis or the market value when you received the gift.
- With inherited assets, the tax basis is generally their fair market value at the time the owner passed away.
- The cost basis for stocks and bonds is their actual price plus any commissions and fees. This amount may adjust if dividends are distributed.
- When like-kind exchanges (think a 1031 exchange for real estate) or corporate reorganizations occur, the existing tax basis is carried over (inherited).
- Upon purchasing a business, the buyer assigns a tax basis to each asset by agreeing to a purchase price allocation.
Tax basis calculations become more complex over time. Dividends reinvested in stocks, for example, purchase additional shares, and are therefore added to the adjusted cost basis. With real estate, buildings depreciate, but land does not. As a result, if you buy land and then sell it for a profit, there is no depreciation to deduct. But the depreciation deduction claimed on a building will decrease the tax basis, thereby increasing the capital gain of that asset upon sale.
Keeping track of every asset’s tax basis, plus all adjustments that may affect it over time, can be difficult. Attorney Tyler Q. Dahl, who is one of fewer than 100 attorneys in the U.S. who has been designated as a Certified Tax Coach and has a Master’s (L.L.M.) in Tax Law, can provide you with the guidance you need to handle complex questions in this area. To schedule a consultation, call 916-545-2790.
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