13.   Basis of Property

Table of Contents

    * Introduction
    * Useful Items - You may want to see:
    * Cost Basis
          o Real Property
    * Adjusted Basis
          o Increases to Basis
          o Decreases to Basis
    * Basis Other Than Cost
          o Property Received for Services
          o Taxable Exchanges
          o Involuntary Conversions
          o Nontaxable Exchanges
          o Property Transferred From a Spouse
          o Property Received as a Gift
          o Inherited Property
          o Property Changed to Business or Rental Use
          o Stocks and Bonds

Introduction

This chapter discusses how to figure your basis in property. It is divided
into the following sections.

    *

      Cost basis.
    *

      Adjusted basis.
    *

      Basis other than cost.

Your basis is the amount of your investment in property for tax purposes.
Use the basis to figure gain or loss on the sale, exchange, or other
disposition of property. Also use it to figure deductions for depreciation,
amortization, depletion, and casualty losses.

If you use property for both business or investment purposes and for
personal purposes, you must allocate the basis based on the use. Only the
basis allocated to the business or investment use of the property can be
depreciated.

Your original basis in property is adjusted (increased or decreased) by
certain events. For example, if you make improvements to the property,
increase your basis. If you take deductions for depreciation or casualty
losses, or claim certain credits, reduce your basis.

Records you should keep
Keep accurate records of all items that affect the basis of your property.
For more information on keeping records, see chapter 1.
Useful Items - You may want to see:

Publication

    *

      15-B Employer's Tax Guide to Fringe Benefits
    *

      525 Taxable and Nontaxable Income
    *

      535 Business Expenses
    *

      537 Installment Sales
    *

      544 Sales and Other Dispositions of Assets
    *

      550 Investment Income and Expenses
    *

      551 Basis of Assets
    *

      564 Mutual Fund Distributions
    *

      946 How To Depreciate Property

Cost Basis

The basis of property you buy is usually its cost. The cost is the amount
you pay in cash, debt obligations, other property, or services. Your cost
also includes amounts you pay for the following items:

    *

      Sales tax (less any applicable sales tax claimed on Schedule A (Form
1040)), 108-357, sec 501">
    *

      Freight,
    *

      Installation and testing,
    *

      Excise taxes,
    *

      Legal and accounting fees (when they must be capitalized),
    *

      Revenue stamps,
    *

      Recording fees, and
    *

      Real estate taxes (if you assume liability for the seller).

In addition, the basis of real estate and business assets may include other
items.
Loans with low or no interest.    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 any amount considered to be unstated interest.
You generally have unstated interest if your interest rate is less than the
applicable federal rate.

  For more information, see Unstated Interest and Original Issue Discount
(OID) in Publication 537.

Real Property

Real property, also called real estate, is land and generally anything
built on, growing on, or attached to land.

If you buy real property, certain fees and other expenses you pay are part
of your cost basis in the property.
Lump sum purchase.   If you buy buildings and the land on which they stand
for a lump sum, allocate the cost basis among the land and the buildings.
Allocate the cost basis according to the respective fair market values
(FMVs) of the land and buildings at the time of purchase. Figure the basis
of each asset by multiplying the lump sum by a fraction. The numerator is
the FMV of that asset and the denominator is the FMV of the whole property
at the time of purchase.

  
Tip
If you are not certain of the FMVs of the land and buildings, you can
allocate the basis according to their assessed values for real estate tax
purposes.

Fair market value (FMV).   FMV is the price at which the 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 the necessary
facts. Sales of similar property on or about the same date may be helpful
in figuring the FMV of the property.

Assumption of mortgage.   If you buy property and assume (or buy the
property subject to) an existing mortgage on the property, your basis
includes the amount you pay for the property plus the amount to be paid on
the mortgage.

Settlement costs.   Your basis includes the settlement fees and closing
costs you paid for buying the property. (A fee for buying property is a
cost that must be paid even if you buy the property for cash.) Do not
include fees and costs for getting a loan on the property in your basis.

  The following are some of the settlement fees or closing costs you can
include in the basis of your property:

    *

      Abstract fees (abstract of title fees);
    *

      Charges for installing utility services;
    *

      Legal fees (including fees for the title search and preparation of
the sales contract and deed);
    *

      Recording fees;
    *

      Survey fees;
    *

      Transfer taxes;
    *

      Owner's title insurance; and
    *

      Any 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.

  Settlement costs do not include amounts placed in escrow for the future
payment of items such as taxes and insurance.

  The following are some of the settlement fees and closing costs you
cannot include in the basis of property:

    *

      Casualty insurance premiums;
    *

      Rent for occupancy of the property before closing;
    *

      Charges for utilities or other services related to occupancy of the
property before closing;
    *

      Charges connected with getting a loan, such as points (discount
points, loan origination fees), mortgage insurance premiums, loan
assumption fees, cost of a credit report, and fees for an appraisal
required by a lender; and
    *

      Fees for refinancing a mortgage.

Real estate taxes.   If you pay 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. You cannot deduct them as an expense.

   If you reimburse the seller for taxes the seller paid for you, you can
usually deduct that amount as an expense in the year of purchase. Do not
include that amount in the basis of your property. If you did not reimburse
the seller, you must reduce your basis by the amount of those taxes.

Points.   If you pay points to get a loan (including a mortgage, second
mortgage, line of credit, or a home equity loan), do not add the points to
the basis of the related property. Generally, you deduct the points over
the term of the loan. For more information on how to deduct points, see
chapter 23.

Points on home mortgage.   Special rules may apply to points you and the
seller pay when you get a mortgage to buy your main home. If certain
requirements are met, you can deduct the points in full for the year in
which they are paid. Reduce the basis of your home by any seller-paid points.

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 (increases and decreases) to the
cost of the property. The result is the adjusted basis.
Increases to Basis

Increase the basis of any property by all items properly added to a capital
account. Examples of items that increase basis are shown in Table 13-1. The
following discussions provide information about many of these items.
Improvements.   Add to your basis in property the cost of improvements
having a useful life of more than 1 year, that increase the value of the
property, lengthen its life, or adapt it to a different use. For example,
improvements include putting a recreation room in your unfinished basement,
adding another bathroom or bedroom, putting up a fence, putting in new
plumbing or wiring, installing a new roof, or paving your driveway.

Assessments for local improvements.   Add to the basis of property
assessments for improvements such as streets and sidewalks if they increase
the value of the property assessed. Do not deduct them as taxes. However,
you can deduct as taxes assessments for maintenance or repairs, or for
meeting interest charges related to the improvements.

Example.

Your city changes the street in front of your store into an enclosed
pedestrian mall and assesses you and other affected property owners for the
cost of the conversion. Add the assessment to your property's basis. In
this example, the assessment is a depreciable asset.
Decreases to Basis

Decrease the basis of any property by all items that represent a return of
capital for the period during which you held the property. Examples of
items that decrease basis are shown in Table 13-1. These include the items
discussed below.

Table 13-1. Examples of Adjustments to Basis
Increases to Basis 	Decreases to Basis
• Capital improvements: 	• Exclusion from income of
  	Putting an addition on your home 	subsidies for energy conservation
  	Replacing an entire roof 	measures
  	Paving your driveway 	 
  	Installing central air conditioning 	• Casualty or theft loss deductions
  	Rewiring your home 	and insurance reimbursements
  	  	 
• Assessments for local improvements: 	• Credit for qualified electric vehicles
  	Water connections 	 
  	Extending utility service lines to the
property 	• Postponed gain from the sale of a home
  	Sidewalks 	• Deduction for clean-fuel vehicles and
  	Roads 	clean-fuel vehicle refueling property
  	  	 
• Casualty losses: 	• Depreciation and section 179 deduction
  	Restoring damaged property 	 
  	• Nontaxable corporate distributions
• Legal fees: 	 
  	Cost of defending and perfecting a title 	• Certain canceled debt
excluded from
  	Fees for getting a reduction of an assessment 	income
  	 
• Zoning costs 	• Easements
  	  	 
  	  	• Adoption tax benefits

Casualty and theft losses.   If you have a casualty or theft loss, decrease
the basis in your property by any insurance proceeds or other reimbursement
and by any deductible loss not covered by insurance.

   You must increase your basis in the property by the amount you spend on
repairs that substantially prolong the life of the property, increase its
value, or adapt it to a different use. To make this determination, compare
the repaired property to the property before the casualty.

  For more information on casualty and theft losses, see chapter 25.

Depreciation and section 179 deduction.   Decrease the basis of your
qualifying business property by any section 179 deduction you take and the
depreciation you deducted, or could have deducted (including any special
depreciation allowance), on your tax returns under the method of
depreciation you selected.

  For more information about depreciation and the section 179 deduction,
see Publication 946.

Example.

You owned a duplex used as rental property that cost you $40,000, of which
$35,000 was allocated to the building and $5,000 to the land. You added an
improvement to the duplex that cost $10,000. In February last year, the
duplex was damaged by fire. Up to that time, you had been allowed
depreciation of $23,000. You sold some salvaged material for $1,300 and
collected $19,700 from your insurance company. You deducted a casualty loss
of $1,000 on your income tax return for last year. You spent $19,000 of the
insurance proceeds for restoration of the duplex, which was completed this
year. You must use the duplex's adjusted basis after the restoration to
determine depreciation for the rest of the property's recovery period.
Figure the adjusted basis of the duplex as follows:
Original cost of duplex 	$35,000
Addition to duplex 	10,000
Total cost of duplex 	$45,000
Minus: 	Depreciation 	23,000
Adjusted basis before casualty 	$22,000
Minus: 	Insurance proceeds 	$19,700 	 
  	Deducted casualty loss 	1,000 	 
  	Salvage proceeds 	1,300 	22,000
Adjusted basis after casualty 	$-0-
Add: Cost of restoring duplex 	19,000
Adjusted basis after restoration 	$19,000

Note.

Your basis in the land is its original cost of $5,000.
Easements.   The amount you receive for granting an easement is generally
considered to be proceeds from the sale of an interest in real property. It
reduces the basis of the affected part of the property. 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.

  If the gain is on a capital asset, see chapter 16 for information about
how to report it. If the gain is on property used in a trade or business,
see Publication 544 for information about how to report it.

Credit for qualified electric vehicles.   If you claim the credit for a
qualified electric vehicle, you must reduce your basis in that vehicle by
the maximum credit allowable even if the credit allowed is less than that
maximum amount. For information on this credit, see chapter 12 in
Publication 535.

Deduction for clean-fuel vehicle and refueling property.   If you take the
deduction for clean-fuel vehicles or clean-fuel vehicle refueling property

placed in service in 2005, decrease the basis of the property by the amount
deducted. For more information about this deduction, see chapter 12 in
Publication 535.

Exclusion of subsidies for energy conservation measures.   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. Reduce the basis of the property for which you received the
subsidy by the excluded amount. For more information about this subsidy,
see chapter 12.

Postponed gain from sale of home.    If you postponed gain from the sale of
your main home under rules in effect before May 7, 1997, you must reduce
the basis of the home you acquired as a replacement by the amount of the
postponed gain. For more information on the rules for the sale of a home,
see chapter 15.

Basis Other Than Cost

There are many times when you cannot use cost as basis. In these cases, the
fair market value or the adjusted basis of the property can be used. Fair
market value (FMV) and adjusted basis were discussed earlier.
Property Received for Services

If you receive property for your services, include its FMV in income. The
amount you include in income becomes your basis. 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.
Restricted property.   If you receive property for your services and the
property is subject to certain restrictions, your basis in the property is
its FMV when it becomes substantially vested. However, this rule does not
apply if you make an election to include in income the FMV of the property
at the time it is transferred to you, less any amount you paid for it.
Property is substantially vested when it is transferable or when it is not
subject to a substantial risk of forfeiture (you do not have a good chance
of losing it). For more information, see Restricted Property in Publication
525.

Bargain purchases.   A bargain purchase is a purchase of an item for less
than its FMV. If, as compensation for services, you buy goods or other
property at less than FMV, include the difference between the purchase
price and the property's FMV in your income. Your basis in the property is
its FMV (your purchase price plus the amount you include in income).

   If the difference between your purchase price and the FMV is a qualified
employee discount, do not include the difference in income. However, your
basis in the property is still its FMV. See Employee Discounts in
Publication 15-B.

Taxable Exchanges

A taxable exchange is one in which the gain is taxable or the loss is
deductible. A taxable gain or deductible loss also is known as a recognized
gain or loss. 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.
Involuntary Conversions

If you receive replacement property as a result of an involuntary
conversion, such as a casualty, theft, or condemnation, figure the basis of
the replacement property using the basis of the converted property.
Similar or related property.   If you receive replacement property similar
or related in service or use to the converted property, the replacement
property's basis is the same as the converted property's basis on the date
of the conversion, with the following adjustments.

   1.

      Decrease the basis by the following.
         1.

            Any loss you recognize on the involuntary conversion.
         2.

            Any money you receive that you do not spend on similar property.
   2.

      Increase the basis by the following.
         1.

            Any gain you recognize on the involuntary conversion.
         2.

            Any cost of acquiring the replacement property.

Money or property not similar or related.    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 conversion.

Example.

The state condemned your property. The adjusted basis of the property was
$26,000 and the state paid you $31,000 for it. You realized a gain of
$5,000 ($31,000 - $26,000). You bought replacement property similar in use
to the converted property for $29,000. You recognize a gain of $2,000
($31,000 - $29,000), the unspent part of the payment from the state. Your
unrecognized gain is $3,000, the difference between the $5,000 realized
gain and the $2,000 recognized gain. The basis of the replacement property
is figured as follows:
Cost of replacement property 	$29,000
Minus: Gain not recognized 	3,000
Basis of replacement property 	$26,000

Allocating the basis.   If you buy more than one piece of replacement
property, allocate your basis among the properties based on their
respective costs.

Basis for depreciation.   Special rules apply in determining and
depreciating the basis of MACRS property acquired in an involuntary
conversion. For information, see What Is the Basis of Your Depreciable
Property? in chapter 1 of Publication 946.

Nontaxable Exchanges

A nontaxable exchange is an exchange in which you are not taxed on any gain
and you cannot deduct any loss. If you receive property in a nontaxable
exchange, its basis is generally the same as the basis of the property you
transferred. See Nontaxable Trades in chapter 14.
Like-Kind Exchanges

The exchange of property for the same kind of property is the most common
type of nontaxable exchange. To qualify as a like-kind exchange, the
property traded and the property received must be both of the following.

    *

      Qualifying property.
    *

      Like-kind property.

The basis of the property you receive is generally the same as the adjusted
basis of the property you gave up. If you trade property in a like-kind
exchange and also pay money, the basis of the property received is the
adjusted basis of the property you gave up increased by the money you paid.
Qualifying property.   In a like-kind exchange, you must hold for
investment or for productive use in your trade or business both the
property you give up and the property you receive.

Like-kind property.   There must be an exchange of like-kind property.
Like-kind properties are properties of the same nature or character, even
if they differ in grade or quality. The exchange of real estate for real
estate and personal property for similar personal property are exchanges of
like-kind property.

Example.

You trade in an old truck used in your business with an adjusted basis of
$1,700 for a new one costing $6,800. The dealer allows you $2,000 on the
old truck, and you pay $4,800. This is a like-kind exchange. The basis of
the new truck is $6,500 (the adjusted basis of the old one, $1,700, plus
the amount you paid, $4,800).

If you sell your old truck to a third party for $2,000 instead of trading
it in and then buy a new one from the dealer, you have a taxable gain of
$300 on the sale (the $2,000 sale price minus the $1,700 adjusted basis).
The basis of the new truck is the price you pay the dealer.
Partially nontaxable exchanges.   A partially nontaxable exchange is an
exchange in which you receive unlike property or money in addition to
like-kind property. The basis of the property you receive is the same as
the adjusted basis of the property you gave up, with the following adjustments.

   1.

      Decrease the basis by the following amounts.
         1.

            Any money you receive.
         2.

            Any loss you recognize on the exchange.
   2.

      Increase the basis by the following amounts.
         1.

            Any additional costs you incur.
         2.

            Any gain you recognize on the exchange.

If the other party to the exchange assumes your liabilities, treat the debt
assumption as money you received in the exchange.

Allocation of basis.   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. The rest is the basis of
the like-kind property.

More information.   See Like-Kind Exchanges in chapter 1 of Publication 544
for more information.

Basis for depreciation.   Special rules apply in determining and
depreciating the basis of MACRS property acquired in a like-kind exchange.
For information, see What Is the Basis of Your Depreciable Property? in
chapter 1 of Publication 946.

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. The
same rule applies to a transfer by your former spouse that is incident to
divorce. 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.

If the property transferred to you is a series E, series EE, or series I
U.S. savings bond, the transferor must include in income the interest
accrued to the date of transfer. Your basis in the bond immediately after
the transfer is equal to the transferor's basis increased by the interest
income includible in the transferor's income. For more information on these
bonds, see chapter 7.

At the time of the transfer, 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.

For more information about the transfer of property from a spouse, see
chapter 14.
Property Received as a Gift

To figure the basis of property you receive as a gift, you must know its
adjusted basis to the donor just before it was given to you, its FMV at the
time it was given to you, and any gift tax paid on it.
FMV less than donor's adjusted basis.   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. Your basis for figuring gain is the same as the donor's adjusted
basis plus or minus any required adjustments to basis while you held the
property. 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. See Adjusted Basis, earlier.

Example.

You received an acre of land as a gift. At the time of the gift, the land
had an FMV of $8,000. The donor's adjusted basis was $10,000. After you
received the property, no events occurred to increase or decrease your
basis. If you later sell the property for $12,000, you will have a $2,000
gain because you must use the donor's adjusted basis at the time of the
gift ($10,000) as your basis to figure gain. If you sell the property for
$7,000, you will have a $1,000 loss because you must use the FMV at the
time of the gift ($8,000) as your basis to figure loss.

If the sales price is between $8,000 and $10,000, you have neither gain nor
loss.
Business property.   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.

FMV equal to or greater than donor's adjusted basis.   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 at the time you received the gift. Increase
your basis by all or part of any gift tax paid, depending on the date of
the gift, explained later.

  Also, for figuring gain or loss from a sale or other disposition 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.
See Adjusted Basis, earlier.

  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. Figure the increase by
multiplying the gift tax paid by a fraction. The numerator of the fraction
is the net increase in value of the gift and the denominator is the amount
of the gift.

  The net increase in value of the gift is the FMV of the gift minus the
donor's adjusted basis. 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. For information on the gift tax, see
Publication 950, Introduction to Estate and Gift Taxes.

Example.

In 2005, you received a gift of property from your mother that had an FMV
of $50,000. Her adjusted basis was $20,000. The amount of the gift for gift
tax purposes was $39,000 ($50,000 minus the $11,000 annual exclusion). She
paid a gift tax of $9,000 on the property. Your basis is $26,930, figured
as follows:

Fair market value 	$50,000
Minus: Adjusted basis 	-20,000
Net increase in value 	$30,000
  	 
Gift tax paid 	$9,000
Multiplied by ($30,000 χ $39,000) 	Χ .77
Gift tax due to net increase in value 	$6,930
Adjusted basis of property to your mother 	+20,000
Your basis in the property 	$26,930

Note.

If you received a gift before 1977, your basis in the gift (the donor's
adjusted basis) includes any gift tax paid on it. However, your basis
cannot exceed the FMV of the gift at the time it was given to you.
Inherited Property

Your basis in property you inherit from a decedent is generally one of the
following.

    *

      The FMV of the property at the date of the decedent's death.
    *

      The FMV on the alternate valuation date if the personal
representative for the estate elects to use alternate valuation.
    *

      The value under the special-use valuation method for real property
used in farming or a closely held business if elected for estate tax purposes.
    *

      The decedent's adjusted basis in land to the extent of the value
excluded from the decedent's taxable estate as a qualified conservation
easement.

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.

For more information, see the instructions to Form 706, United States
Estate (and Generation-Skipping Transfer) Tax Return.
Community property.   In community property states (Arizona, California,
Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin),
husband and wife are each usually considered to own half the community
property. When either spouse dies, the total value of the community
property, even the part belonging to the surviving spouse, generally
becomes the basis of the entire property. For this rule to apply, at least
half the value of the community property interest must be includible in the
decedent's gross estate, whether or not the estate must file a return.

Example.   You and your spouse owned community property that had a basis of
$80,000. When your spouse died, half the FMV of the community interest was
includible in your spouse's estate. The FMV of the community interest was
$100,000. The basis of your half of the property after the death of your
spouse is $50,000 (half of the $100,000 FMV). The basis of the other half
to your spouse's heirs is also $50,000.

  For more information about community property, see Publication 555,
Community Property.

Property Changed to Business or Rental Use

If you hold property for personal use and then change it to business use or
use it to produce rent, you can begin to depreciate the property at the
time of the change. To do so, you must figure its basis for depreciation.
An example of changing property held for personal use to business or rental
use would be renting out your former personal residence.
Basis for depreciation.   The basis for depreciation is the lesser of the
following amounts.

    *

      The FMV of the property on the date of the change.
    *

      Your adjusted basis on the date of the change.

Example.

Several years ago, you paid $160,000 to have your house built on a lot that
cost $25,000. You paid $20,000 for permanent improvements to the house and
claimed a $2,000 casualty loss deduction for damage to the house before
changing the property to rental use last year. Because land is not
depreciable, you include only the cost of the house when figuring the basis
for depreciation.

Your adjusted basis in the house when you changed its use was $178,000
($160,000 + $20,000 - $2,000). On the same date, your property had an FMV
of $180,000, of which $15,000 was for the land and $165,000 was for the
house. The basis for figuring depreciation on the house is its FMV on the
date of the change ($165,000) because it is less than your adjusted basis
($178,000).
Sale of property.   If you later sell or dispose of property changed to
business or rental use, the basis you use will depend on whether you are
figuring gain or loss.

Gain.   The basis for figuring a gain is your adjusted basis in the
property when you sell the property.

Example.

Assume the same facts as in the previous example except that you sell the
property at a gain after being allowed depreciation deductions of $37,500.
Your adjusted basis for figuring gain is $165,500 ($178,000 + $25,000
(land) - $37,500).
Loss.   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. Then make adjustments (increases and decreases) for
the period after the change in the property's use, as discussed earlier
under Adjusted Basis.

Example.

Assume the same facts as in the previous example, except that you sell the
property at a loss after being allowed depreciation deductions of $37,500.
In this case, you would start with the FMV on the date of the change to
rental use ($180,000), because it is less than the adjusted basis of
$203,000 ($178,000 + $25,000 (land)) on that date. Reduce that amount
($180,000) by the depreciation deductions ($37,500). The basis for loss is
$142,500 ($180,000 - $37,500).
Stocks and Bonds

The basis of stocks or bonds you buy generally is the purchase price plus
any costs of purchase, such as commissions and recording or transfer fees.
If you get stocks or bonds other than by purchase, your basis is usually
determined by the FMV or the previous owner's adjusted basis, as discussed
earlier.

You must adjust the basis of stocks for certain events that occur after
purchase. For example, if you receive additional stock from nontaxable
stock dividends or stock splits, reduce your basis for each share of stock
by dividing the adjusted basis of the old stock by the number of shares of
old and new stock. This rule applies only when the additional stock
received is identical to the stock held. Also reduce your basis when you
receive nontaxable distributions. They are a return of capital.

Example.

In 2003 you bought 100 shares of XYZ stock for $1,000 or $10 a share. In
2004 you bought 100 shares of XYZ stock for $1,600 or $16 a share. In 2005
XYZ declared a 2-for-1 stock split. You now have 200 shares of stock with a
basis of $5 a share and 200 shares with a basis of $8 a share.
Other basis.   There are other ways to figure the basis of stocks or bonds
depending on how you acquired them. For detailed information, see Stocks
and Bonds under Basis of Investment Property in chapter 4 of Publication 550.

Identifying stocks or bonds sold.   If you can adequately identify the
shares of stock or the bonds you sold, their basis is the cost or other
basis of the particular shares of stocks or bonds. If you buy and sell
securities at various times in varying quantities and you cannot adequately
identify the shares you sell, the basis of the securities you sell is the
basis of the securities you acquired first. For more information about
identifying securities you sell, see Stocks and Bonds under Basis of
Investment Property in chapter 4 of Publication 550.

Mutual fund shares.   If you sell mutual fund shares you acquired at
various times and prices and left on deposit in an account kept by a
custodian or agent, you can elect to use an average basis. For more
information, see Publication 564.

Bond premium.   If you buy a taxable bond at a premium and elect to
amortize the premium, reduce the basis of the bond by the amortized premium
you deduct each year. See Bond Premium Amortization in chapter 3 of
Publication 550 for more information. Although you cannot deduct the
premium on a tax-exempt bond, you must amortize the premium each year and
reduce your basis in the bond by the amortized amount.

Original issue discount (OID) on debt instruments.   You must increase your
basis in an OID debt instrument by the OID you include in income for that
instrument. See Original Issue Discount (OID) in chapter 7 and Publication
1212, List of Original Issue Discount Instruments.

Tax-exempt obligations.    OID on tax-exempt obligations is generally not
taxable. However, when you dispose of a tax-exempt obligation issued after
September 3, 1982, and acquired after March 1, 1984, you must accrue OID on
the obligation to determine its adjusted basis. The accrued OID is added to
the basis of the obligation to determine your gain or loss. See chapter 4
of Publication 550.