First, what is basis?
Basis is what you get when you buy something. What does that mean? Back up for a second… when you sell something, your gain is calculated as Proceeds – Basis = Gain (or Loss). Based on this calculation, higher basis means lower gain, and lower gain (generally) means lower taxes. If you buy property for $500,000, you get basis in that property for the $500,000 that you paid. You can also get additional basis for things like closing costs from buying property and spending money to improve the property.
How should I track my basis?
Keep and maintain your records and receipts! If you sell a piece of property for a gain, it will be reported on your tax return, and it is possible that the IRS will ask for proof of the basis you claimed when calculating the taxable gain. These records and receipts are the proof you will need to prove that your taxable gain was calculated correctly and accurately.
Why are you telling me this now?
While it has always been important to diligently track your basis in property you own, a recent court case has shown yet another reason why this is so crucial. An Oklahoma couple claimed a loss on their tax return for tornado damage sustained on two parcels of land that they own ($88,000 for one parcel, $39,900 for the other). The IRS disallowed the deduction, stating that they had not accurately valued the properties after the damage. The case went to the Tax Court, and the court disagreed with the IRS, stating that the couple had accurately valued the properties and were therefore entitled to a loss equal to a decline in value equal to Basis – Value of Property After Damages.
However, the taxpayer could not provide any records proving that he had basis in one of the properties, which he had purchased from his mother. At the end of the day, the IRS allowed the deduction for the damage to the parcel for which he could substantiate his basis, but did not allow it on the parcel for which he could not provide adequate proof of his basis.
It is always important to track your basis in property that you own, even if it is personal property and even if it can be a little tedious or annoying. Not sure if this applies to you? Ask us! We can help!