Knowing the cost basis of your property is important for tax purposes, but proving cost basis can be difficult. Cost basis adjusts at death, so it is always a good idea to appraise your property when a joint owner dies.
What is Cost Basis?
Cost basis is the monetary value of an item for tax purposes. To calculate how much you owe in capital gains tax on property, you use the basis to determine whether an asset has increased or decreased in value.
For example, if you purchase a house for $150,000, that is the cost basis. If you then make improvements to the property, you may be able to increase the home’s cost basis.
Suppose that you make no improvements, and you later sell the house for $250,000. You will have to pay taxes on the $100,000 increase in value. (However, if the property is your principal residence, you can exclude up to $250,000 in capital gains, or up to $500,000 for a couple.)
What Happens to Cost Basis When a Property Owner Dies?
When a property owner dies, the cost basis of the property is "stepped up." This means the current value of the property becomes the basis.
For example, imagine you inherit a house that a family member had purchased years ago for $50,000. The home has increased in value over time, and when the family member who owned the property dies, the home is worth $250,000. You will therefore receive a step up from the original cost basis – from $50,000 to $250,000. If you sell the property right away, you will not owe any capital gains taxes.
When a joint owner dies, half of the value of the property is stepped up. For example, suppose a couple buys property for $200,000, and then the husband dies when the property has a fair market value of $300,000. The new basis of the property for the wife will be $250,000. That is, $100,000 (for the wife’s original 50 percent interest) plus $150,000 (for the other half passed to her at her husband’s death) = $250,000.
There are other scenarios that can affect a property’s cost basis as well as any capital gains taxes you may owe.
For example, your home may have decreased in value over time for some reason. This could have an impact on the cost basis.
Perhaps you are considering gifting a piece of property to your children. Should you transfer the home to your kids during your lifetime, or let them inherit it after you have died? How would this affect the cost basis? Also, what would the tax implications be of each option?
Either way, connect with an experienced estate planner to understand the best options for your unique circ*mstances. Professionals with expertise in this area can also assist you in creating a plan that avoids negative tax consequences where possible.
Proving Your Cost Basis
The burden is on the property owner to prove the cost basis. It isn't always easy to do, especially if a considerable amount of time has passed since the owner purchased the property or made improvements to it. Homeowners should keep good records of improvements they have made to a house, including keeping copies of all receipts and purchase orders.
If a joint owner of property dies, you should get the property appraised to show the value at the time it is stepped up in basis. Be sure to save the documentation so you can use it later.
Additional Resources
Again, a qualified estate planner can guide you on what your best options are in these situations. Search for an estate planning attorney near you today.
You may also benefit from checking out the following informative articles related to taxes and estate planning:
Created date: 10/20/2015
FAQs
Cost basis is the original value of an asset for tax purposes—usually the purchase price, adjusted for stock splits, dividends, and return of capital distributions. This value is used to determine the capital gain, which is equal to the difference between the asset's cost basis and the current market value.
How do I prove my IRS cost basis? ›
If you purchased the asset, documents from the original sale are the preferred option for verifying cost basis. This can include any brokerage statements, commission statements or other proof of purchase for securities that you purchased.
How do you determine cost basis? ›
For stocks and bonds, the cost basis is generally your purchase price for the securities, including reinvested dividends or reinvested capital gains distributions, plus additional costs such as the commission or other fees you paid to complete the transaction.
What do I do if I don't know my cost basis? ›
If you know when the stock was purchased, here are some tips:
- Sign in to your brokerage account. ...
- Look at previous broker statements. ...
- Contact your brokerage firm. ...
- Go online for historical stock prices. ...
- Go directly to the source.
How Do I Calculate Cost Basis for Real Estate?
- Start with the original investment in the property.
- Add the cost of major improvements.
- Subtract the amount of allowable depreciation and casualty and theft losses.
The easiest way to track and calculate cost basis is through brokerage firms. Whether an investor has an online or traditional brokerage account, firms have very sophisticated systems that maintain records of transactions and corporate actions related to stocks.
What cannot be included in the cost basis of a main home? ›
The cost includes the cost of materials, equipment, and labor. However, you may not add the cost of your own labor to the property's basis. Add the interest you pay on construction loans during the construction period, but deduct interest you pay before and after construction as an operating expense.
What is the most common cost basis method? ›
The average cost basis method is commonly used by investors for mutual fund tax reporting. A cost basis method is reported with the brokerage firm where the assets are held. The average cost is calculated by dividing the total amount in dollars invested in a mutual fund position by the number of shares owned.
Does return of capital reduce cost basis? ›
RoC typically is not taxed in the current year. Instead, it reduces a shareholder's cost basis in the fund. When the shareholder sells his or her fund shares, any gains will consider the selling price relative to the reduced cost basis. This means that RoC may defer some of the shareholder's tax liability.
What is the average price for cost basis? ›
Average cost method
Average cost is calculated by taking the total cost of the shares you own and dividing by the total number of shares. Be aware, if you select this method for cost basis reporting, you must use it for all shares bought before that initial stock sale.
How can we help? The Form 1099-B that you receive might only report the sale date and sales proceeds. If it does not report the date acquired or cost basis, you still need to enter that information when you report your Form 1099-B in the TaxAct program so that it will transfer to Schedule D and/or Form 8949.
Why are some cost basis not reported to IRS? ›
A noncovered security is an SEC designation indicating that a broker does not have to report the cost basis of that security to the IRS. This is generally for smaller securities. Securities created from noncovered securities, such as stock splits or DRIP accounts, remain noncovered.
Where can I find my adjusted cost basis? ›
The cost basis reported on Form 1099-B reflects the purchase price only and doesn't account for income reported by your employer, due to IRS regulations. The Supplemental Information Form will show an adjusted cost basis that accounts for the income reported by your employer.
How does IRS verify cost basis? ›
The IRS expects taxpayers to keep the original documentation for capital assets, such as real estate and investments. It uses these documents, along with third-party records, bank statements and published market data, to verify the cost basis of assets.
How do you calculate cost basis? ›
You can calculate your cost basis per share in two ways: Take the original investment amount ($10,000) and divide it by the new number of shares you hold (2,000 shares) to arrive at the new per-share cost basis ($10,000 ÷ 2,000 = $5.00).
How do you prove basis in inherited property? ›
The basis of property inherited from a decedent is generally one of the following: The fair market value (FMV) of the property on the date of the decedent's death (whether or not the executor of the estate files an estate tax return (Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return)).
What is the cost basis document? ›
The cost basis reported on Form 1099-B reflects the purchase price only and doesn't account for income reported by your employer, due to IRS regulations. The Supplemental Information Form will show an adjusted cost basis that accounts for the income reported by your employer. file your taxes.
What happens if 1099-B does not show cost basis? ›
How can we help? The Form 1099-B that you receive might only report the sale date and sales proceeds. If it does not report the date acquired or cost basis, you still need to enter that information when you report your Form 1099-B in the TaxAct program so that it will transfer to Schedule D and/or Form 8949.
How does the IRS determine the FMV of an inherited home? ›
You can use a CMA (by a real estate agent or broker) for FMV, but the IRS considers the best evidence of FMV to be an appraisal by a certified real estate appraiser.
What is proof of expense for IRS? ›
Documents for expenses include the following: Canceled checks or other documents reflecting proof of payment/electronic funds transferred. Cash register tape receipts. Account statements.
Knowing the cost basis of your property is important for tax purposes, but proving cost basis can be difficult. Cost basis adjusts at death, so it is always a good idea to appraise your property when a joint owner dies.
