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Free tax h&r block 1. Free tax h&r block   Deducting Business Expenses Table of Contents What's New Introduction Topics - This chapter discusses: Useful Items - You may want to see: What Can I Deduct?Cost of Goods Sold Capital Expenses Capital versus Deductible Expenses Personal versus Business Expenses How Much Can I Deduct?Not-for-profit limits. Free tax h&r block At-risk limits. Free tax h&r block Passive activities. Free tax h&r block Net operating loss. Free tax h&r block When Can I Deduct an Expense?Economic performance. Free tax h&r block Not-for-Profit ActivitiesGross Income Limit on Deductions What's New Optional safe harbor method to determine the business use of a home deduction. Free tax h&r block  Beginning in 2013, you can use the optional safe harbor method to determine the deduction for the business use of your home. Free tax h&r block See Optional safe harbor method under Business use of your home , later. Free tax h&r block Introduction This chapter covers the general rules for deducting business expenses. Free tax h&r block Business expenses are the costs of carrying on a trade or business, and they are usually deductible if the business is operated to make a profit. Free tax h&r block Topics - This chapter discusses: What you can deduct How much you can deduct When you can deduct Not-for-profit activities Useful Items - You may want to see: Publication 334 Tax Guide for Small Business 463 Travel, Entertainment, Gift, and Car Expenses 525 Taxable and Nontaxable Income 529 Miscellaneous Deductions 536 Net Operating Losses (NOLs) for Individuals, Estates, and Trusts 538 Accounting Periods and Methods 542 Corporations 547 Casualties, Disasters, and Thefts 587 Business Use of Your Home 925 Passive Activity and At-Risk Rules 936 Home Mortgage Interest Deduction 946 How To Depreciate Property Form (and Instructions) Sch A (Form 1040) Itemized Deductions 5213 Election To Postpone Determination as To Whether the Presumption Applies That an Activity Is Engaged in for Profit See chapter 12 for information about getting publications and forms. Free tax h&r block What Can I Deduct? To be deductible, a business expense must be both ordinary and necessary. Free tax h&r block An ordinary expense is one that is common and accepted in your industry. Free tax h&r block A necessary expense is one that is helpful and appropriate for your trade or business. Free tax h&r block An expense does not have to be indispensable to be considered necessary. Free tax h&r block Even though an expense may be ordinary and necessary, you may not be allowed to deduct the expense in the year you paid or incurred it. Free tax h&r block In some cases you may not be allowed to deduct the expense at all. Free tax h&r block Therefore, it is important to distinguish usual business expenses from expenses that include the following. Free tax h&r block The expenses used to figure cost of goods sold, Capital expenses, and Personal expenses. Free tax h&r block Cost of Goods Sold If your business manufactures products or purchases them for resale, you generally must value inventory at the beginning and end of each tax year to determine your cost of goods sold. Free tax h&r block Some of your business expenses may be included in figuring cost of goods sold. Free tax h&r block Cost of goods sold is deducted from your gross receipts to figure your gross profit for the year. Free tax h&r block If you include an expense in the cost of goods sold, you cannot deduct it again as a business expense. Free tax h&r block The following are types of expenses that go into figuring cost of goods sold. Free tax h&r block The cost of products or raw materials, including freight. Free tax h&r block Storage. Free tax h&r block Direct labor (including contributions to pension or annuity plans) for workers who produce the products. Free tax h&r block Factory overhead. Free tax h&r block Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Free tax h&r block Indirect costs include rent, interest, taxes, storage, purchasing, processing, repackaging, handling, and administrative costs. Free tax h&r block This rule does not apply to personal property you acquire for resale if your average annual gross receipts (or those of your predecessor) for the preceding 3 tax years are not more than $10 million. Free tax h&r block For more information, see the following sources. Free tax h&r block Cost of goods sold—chapter 6 of Publication 334. Free tax h&r block Inventories—Publication 538. Free tax h&r block Uniform capitalization rules—Publication 538 and section 263A of the Internal Revenue Code and the related regulations. Free tax h&r block Capital Expenses You must capitalize, rather than deduct, some costs. Free tax h&r block These costs are a part of your investment in your business and are called “capital expenses. Free tax h&r block ” Capital expenses are considered assets in your business. Free tax h&r block In general, you capitalize three types of costs. Free tax h&r block Business start-up costs (See Tip below). Free tax h&r block Business assets. Free tax h&r block Improvements. Free tax h&r block You can elect to deduct or amortize certain business start-up costs. Free tax h&r block See chapters 7 and 8. Free tax h&r block Cost recovery. Free tax h&r block   Although you generally cannot take a current deduction for a capital expense, you may be able to recover the amount you spend through depreciation, amortization, or depletion. Free tax h&r block These recovery methods allow you to deduct part of your cost each year. Free tax h&r block In this way, you are able to recover your capital expense. Free tax h&r block See Amortization (chapter 8) and Depletion (chapter 9) in this publication. Free tax h&r block A taxpayer can elect to deduct a portion of the costs of certain depreciable property as a section 179 deduction. Free tax h&r block A greater portion of these costs can be deducted if the property is qualified disaster assistance property. Free tax h&r block See Publication 946 for details. Free tax h&r block Going Into Business The costs of getting started in business, before you actually begin business operations, are capital expenses. Free tax h&r block These costs may include expenses for advertising, travel, or wages for training employees. Free tax h&r block If you go into business. Free tax h&r block   When you go into business, treat all costs you had to get your business started as capital expenses. Free tax h&r block   Usually you recover costs for a particular asset through depreciation. Free tax h&r block Generally, you cannot recover other costs until you sell the business or otherwise go out of business. Free tax h&r block However, you can choose to amortize certain costs for setting up your business. Free tax h&r block See Starting a Business in chapter 8 for more information on business start-up costs. Free tax h&r block If your attempt to go into business is unsuccessful. Free tax h&r block   If you are an individual and your attempt to go into business is not successful, the expenses you had in trying to establish yourself in business fall into two categories. Free tax h&r block The costs you had before making a decision to acquire or begin a specific business. Free tax h&r block These costs are personal and nondeductible. Free tax h&r block They include any costs incurred during a general search for, or preliminary investigation of, a business or investment possibility. Free tax h&r block The costs you had in your attempt to acquire or begin a specific business. Free tax h&r block These costs are capital expenses and you can deduct them as a capital loss. Free tax h&r block   If you are a corporation and your attempt to go into a new trade or business is not successful, you may be able to deduct all investigatory costs as a loss. Free tax h&r block   The costs of any assets acquired during your unsuccessful attempt to go into business are a part of your basis in the assets. Free tax h&r block You cannot take a deduction for these costs. Free tax h&r block You will recover the costs of these assets when you dispose of them. Free tax h&r block Business Assets There are many different kinds of business assets; for example, land, buildings, machinery, furniture, trucks, patents, and franchise rights. Free tax h&r block You must fully capitalize the cost of these assets, including freight and installation charges. Free tax h&r block Certain property you produce for use in your trade or business must be capitalized under the uniform capitalization rules. Free tax h&r block See Regulations section 1. Free tax h&r block 263A-2 for information on these rules. Free tax h&r block Improvements Improvements are generally major expenditures. Free tax h&r block Some examples are: new electric wiring, a new roof, a new floor, new plumbing, bricking up windows to strengthen a wall, and lighting improvements. Free tax h&r block The costs of making improvements to a business asset are capital expenses if the improvements add to the value of the asset, appreciably lengthen the time you can use it, or adapt it to a different use. Free tax h&r block Beginning in 2014, you must capitalize as improvements costs that are for the betterment of a unit of property, restore the unit of property, or adapt the unit of property to a new or different use. Free tax h&r block Temporary regulations allow you to capitalize costs meeting the above criteria for tax years beginning after 2011. Free tax h&r block However, you can currently deduct repairs that keep your property in a normal efficient operating condition as a business expense. Free tax h&r block Treat as repairs amounts paid to replace parts of a machine that only keep it in a normal operating condition. Free tax h&r block Restoration plan. Free tax h&r block   Capitalize the cost of reconditioning, improving, or altering your property as part of a general restoration plan to make it suitable for your business. Free tax h&r block This applies even if some of the work would by itself be classified as repairs. Free tax h&r block Capital versus Deductible Expenses To help you distinguish between capital and deductible expenses, different examples are given below. Free tax h&r block Motor vehicles. Free tax h&r block   You usually capitalize the cost of a motor vehicle you use in your business. Free tax h&r block You can recover its cost through annual deductions for depreciation. Free tax h&r block   There are dollar limits on the depreciation you can claim each year on passenger automobiles used in your business. Free tax h&r block See Publication 463. Free tax h&r block   Generally, repairs you make to your business vehicle are currently deductible. Free tax h&r block However, amounts you pay to recondition and overhaul a business vehicle are capital expenses and are recovered through depreciation. Free tax h&r block Roads and driveways. Free tax h&r block    The cost of building a private road on your business property and the cost of replacing a gravel driveway with a concrete one are capital expenses you may be able to depreciate. Free tax h&r block The cost of maintaining a private road on your business property is a deductible expense. Free tax h&r block Tools. Free tax h&r block   Unless the uniform capitalization rules apply, amounts spent for tools used in your business are deductible expenses if the tools have a life expectancy of less than 1 year or their cost is minor. Free tax h&r block Machinery parts. Free tax h&r block   Unless the uniform capitalization rules apply, the cost of replacing short-lived parts of a machine to keep it in good working condition, but not add to its life, is a deductible expense. Free tax h&r block Heating equipment. Free tax h&r block   The cost of changing from one heating system to another is a capital expense. Free tax h&r block Personal versus Business Expenses Generally, you cannot deduct personal, living, or family expenses. Free tax h&r block However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. Free tax h&r block You can deduct the business part. Free tax h&r block For example, if you borrow money and use 70% of it for business and the other 30% for a family vacation, you generally can deduct 70% of the interest as a business expense. Free tax h&r block The remaining 30% is personal interest and generally is not deductible. Free tax h&r block See chapter 4 for information on deducting interest and the allocation rules. Free tax h&r block Business use of your home. Free tax h&r block   If you use part of your home for business, you may be able to deduct expenses for the business use of your home. Free tax h&r block These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. Free tax h&r block   To qualify to claim expenses for the business use of your home, you must meet both of the following tests. Free tax h&r block The business part of your home must be used exclusively and regularly for your trade or business. Free tax h&r block The business part of your home must be: Your principal place of business, or A place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or A separate structure (not attached to your home) used in connection with your trade or business. Free tax h&r block   You generally do not have to meet the exclusive use test for the part of your home that you regularly use either for the storage of inventory or product samples, or as a daycare facility. Free tax h&r block   Your home office qualifies as your principal place of business if you meet the following requirements. Free tax h&r block You use the office exclusively and regularly for administrative or management activities of your trade or business. Free tax h&r block You have no other fixed location where you conduct substantial administrative or management activities of your trade or business. Free tax h&r block   If you have more than one business location, determine your principal place of business based on the following factors. Free tax h&r block The relative importance of the activities performed at each location. Free tax h&r block If the relative importance factor does not determine your principal place of business, consider the time spent at each location. Free tax h&r block Optional safe harbor method. Free tax h&r block   Beginning in 2013, individual taxpayers can use the optional safe harbor method to determine the amount of deductible expenses attributable to certain business use of a residence during the tax year. Free tax h&r block This method is an alternative to the calculation, allocation, and substantiation of actual expenses. Free tax h&r block   The deduction under the optional method is limited to $1,500 per year based on $5 a square foot for up to 300 square feet. Free tax h&r block Under this method, you claim your allowable mortgage interest, real estate taxes, and casualty losses on the home as itemized deductions on Schedule A (Form 1040). Free tax h&r block You are not required to allocate these deductions between personal and business use, as is required under the regular method. Free tax h&r block If you use the optional method, you cannot depreciate the portion of your home used in a trade or business. Free tax h&r block   Business expenses unrelated to the home, such as advertising, supplies, and wages paid to employees, are still fully deductible. Free tax h&r block All of the requirements discussed earlier under Business use of your home still apply. Free tax h&r block   For more information on the deduction for business use of your home, including the optional safe harbor method, see Publication 587. Free tax h&r block    If you were entitled to deduct depreciation on the part of your home used for business, you cannot exclude the part of the gain from the sale of your home that equals any depreciation you deducted (or could have deducted) for periods after May 6, 1997. Free tax h&r block Business use of your car. Free tax h&r block   If you use your car exclusively in your business, you can deduct car expenses. Free tax h&r block If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage. Free tax h&r block Generally, commuting expenses between your home and your business location, within the area of your tax home, are not deductible. Free tax h&r block   You can deduct actual car expenses, which include depreciation (or lease payments), gas and oil, tires, repairs, tune-ups, insurance, and registration fees. Free tax h&r block Or, instead of figuring the business part of these actual expenses, you may be able to use the standard mileage rate to figure your deduction. Free tax h&r block Beginning in 2013, the standard mileage rate is 56. Free tax h&r block 5 cents per mile. Free tax h&r block   If you are self-employed, you can also deduct the business part of interest on your car loan, state and local personal property tax on the car, parking fees, and tolls, whether or not you claim the standard mileage rate. Free tax h&r block   For more information on car expenses and the rules for using the standard mileage rate, see Publication 463. Free tax h&r block How Much Can I Deduct? Generally, you can deduct the full amount of a business expense if it meets the criteria of ordinary and necessary and it is not a capital expense. Free tax h&r block Recovery of amount deducted (tax benefit rule). Free tax h&r block   If you recover part of an expense in the same tax year in which you would have claimed a deduction, reduce your current year expense by the amount of the recovery. Free tax h&r block If you have a recovery in a later year, include the recovered amount in income in that year. Free tax h&r block However, if part of the deduction for the expense did not reduce your tax, you do not have to include that part of the recovered amount in income. Free tax h&r block   For more information on recoveries and the tax benefit rule, see Publication 525. Free tax h&r block Payments in kind. Free tax h&r block   If you provide services to pay a business expense, the amount you can deduct is limited to your out-of-pocket costs. Free tax h&r block You cannot deduct the cost of your own labor. Free tax h&r block   Similarly, if you pay a business expense in goods or other property, you can deduct only what the property costs you. Free tax h&r block If these costs are included in the cost of goods sold, do not deduct them again as a business expense. Free tax h&r block Limits on losses. Free tax h&r block   If your deductions for an investment or business activity are more than the income it brings in, you have a loss. Free tax h&r block There may be limits on how much of the loss you can deduct. Free tax h&r block Not-for-profit limits. Free tax h&r block   If you carry on your business activity without the intention of making a profit, you cannot use a loss from it to offset other income. Free tax h&r block See Not-for-Profit Activities , later. Free tax h&r block At-risk limits. Free tax h&r block   Generally, a deductible loss from a trade or business or other income-producing activity is limited to the investment you have “at risk” in the activity. Free tax h&r block You are at risk in any activity for the following. Free tax h&r block The money and adjusted basis of property you contribute to the activity. Free tax h&r block Amounts you borrow for use in the activity if: You are personally liable for repayment, or You pledge property (other than property used in the activity) as security for the loan. Free tax h&r block For more information, see Publication 925. Free tax h&r block Passive activities. Free tax h&r block   Generally, you are in a passive activity if you have a trade or business activity in which you do not materially participate, or a rental activity. Free tax h&r block In general, deductions for losses from passive activities only offset income from passive activities. Free tax h&r block You cannot use any excess deductions to offset other income. Free tax h&r block In addition, passive activity credits can only offset the tax on net passive income. Free tax h&r block Any excess loss or credits are carried over to later years. Free tax h&r block Suspended passive losses are fully deductible in the year you completely dispose of the activity. Free tax h&r block For more information, see Publication 925. Free tax h&r block Net operating loss. Free tax h&r block   If your deductions are more than your income for the year, you may have a “net operating loss. Free tax h&r block ” You can use a net operating loss to lower your taxes in other years. Free tax h&r block See Publication 536 for more information. Free tax h&r block   See Publication 542 for information about net operating losses of corporations. Free tax h&r block When Can I Deduct an Expense? When you can deduct an expense depends on your accounting method. Free tax h&r block An accounting method is a set of rules used to determine when and how income and expenses are reported. Free tax h&r block The two basic methods are the cash method and the accrual method. Free tax h&r block Whichever method you choose must clearly reflect income. Free tax h&r block For more information on accounting methods, see Publication 538. Free tax h&r block Cash method. Free tax h&r block   Under the cash method of accounting, you generally deduct business expenses in the tax year you pay them. Free tax h&r block Accrual method. Free tax h&r block   Under an accrual method of accounting, you generally deduct business expenses when both of the following apply. Free tax h&r block The all-events test has been met. Free tax h&r block The test is met when: All events have occurred that fix the fact of liability, and The liability can be determined with reasonable accuracy. Free tax h&r block Economic performance has occurred. Free tax h&r block Economic performance. Free tax h&r block   You generally cannot deduct or capitalize a business expense until economic performance occurs. Free tax h&r block If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided, or the property is used. Free tax h&r block If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. Free tax h&r block Example. Free tax h&r block Your tax year is the calendar year. Free tax h&r block In December 2013, the Field Plumbing Company did some repair work at your place of business and sent you a bill for $600. Free tax h&r block You paid it by check in January 2014. Free tax h&r block If you use the accrual method of accounting, deduct the $600 on your tax return for 2013 because all events have occurred to “fix” the fact of liability (in this case the work was completed), the liability can be determined, and economic performance occurred in that year. Free tax h&r block If you use the cash method of accounting, deduct the expense on your 2014 return. Free tax h&r block Prepayment. Free tax h&r block   You generally cannot deduct expenses in advance, even if you pay them in advance. Free tax h&r block This rule applies to both the cash and accrual methods. Free tax h&r block It applies to prepaid interest, prepaid insurance premiums, and any other expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year. Free tax h&r block Example. Free tax h&r block In 2013, you sign a 10-year lease and immediately pay your rent for the first 3 years. Free tax h&r block Even though you paid the rent for 2013, 2014, and 2015, you can only deduct the rent for 2013 on your 2013 tax return. Free tax h&r block You can deduct the rent for 2014 and 2015 on your tax returns for those years. Free tax h&r block Contested liability. Free tax h&r block   Under the cash method, you can deduct a contested liability only in the year you pay the liability. Free tax h&r block Under the accrual method, you can deduct contested liabilities such as taxes (except foreign or U. Free tax h&r block S. Free tax h&r block possession income, war profits, and excess profits taxes) either in the tax year you pay the liability (or transfer money or other property to satisfy the obligation) or in the tax year you settle the contest. Free tax h&r block However, to take the deduction in the year of payment or transfer, you must meet certain conditions. Free tax h&r block See Regulations section 1. Free tax h&r block 461-2. Free tax h&r block Related person. Free tax h&r block   Under an accrual method of accounting, you generally deduct expenses when you incur them, even if you have not yet paid them. Free tax h&r block However, if you and the person you owe are related and that person uses the cash method of accounting, you must pay the expense before you can deduct it. Free tax h&r block Your deduction is allowed when the amount is includible in income by the related cash method payee. Free tax h&r block See Related Persons in Publication 538. Free tax h&r block Not-for-Profit Activities If you do not carry on your business or investment activity to make a profit, you cannot use a loss from the activity to offset other income. Free tax h&r block Activities you do as a hobby, or mainly for sport or recreation, are often not entered into for profit. Free tax h&r block The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. Free tax h&r block It does not apply to corporations other than S corporations. Free tax h&r block In determining whether you are carrying on an activity for profit, several factors are taken into account. Free tax h&r block No one factor alone is decisive. Free tax h&r block Among the factors to consider are whether: You carry on the activity in a businesslike manner, The time and effort you put into the activity indicate you intend to make it profitable, You depend on the income for your livelihood, Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business), You change your methods of operation in an attempt to improve profitability, You (or your advisors) have the knowledge needed to carry on the activity as a successful business, You were successful in making a profit in similar activities in the past, The activity makes a profit in some years, and You can expect to make a future profit from the appreciation of the assets used in the activity. Free tax h&r block Presumption of profit. Free tax h&r block   An activity is presumed carried on for profit if it produced a profit in at least 3 of the last 5 tax years, including the current year. Free tax h&r block Activities that consist primarily of breeding, training, showing, or racing horses are presumed carried on for profit if they produced a profit in at least 2 of the last 7 tax years, including the current year. Free tax h&r block The activity must be substantially the same for each year within this period. Free tax h&r block You have a profit when the gross income from an activity exceeds the deductions. Free tax h&r block   If a taxpayer dies before the end of the 5-year (or 7-year) period, the “test” period ends on the date of the taxpayer's death. Free tax h&r block   If your business or investment activity passes this 3- (or 2-) years-of-profit test, the IRS will presume it is carried on for profit. Free tax h&r block This means the limits discussed here will not apply. Free tax h&r block You can take all your business deductions from the activity, even for the years that you have a loss. Free tax h&r block You can rely on this presumption unless the IRS later shows it to be invalid. Free tax h&r block Using the presumption later. Free tax h&r block   If you are starting an activity and do not have 3 (or 2) years showing a profit, you can elect to have the presumption made after you have the 5 (or 7) years of experience allowed by the test. Free tax h&r block   You can elect to do this by filing Form 5213. Free tax h&r block Filing this form postpones any determination that your activity is not carried on for profit until 5 (or 7) years have passed since you started the activity. Free tax h&r block   The benefit gained by making this election is that the IRS will not immediately question whether your activity is engaged in for profit. Free tax h&r block Accordingly, it will not restrict your deductions. Free tax h&r block Rather, you will gain time to earn a profit in the required number of years. Free tax h&r block If you show 3 (or 2) years of profit at the end of this period, your deductions are not limited under these rules. Free tax h&r block If you do not have 3 (or 2) years of profit, the limit can be applied retroactively to any year with a loss in the 5-year (or 7-year) period. Free tax h&r block   Filing Form 5213 automatically extends the period of limitations on any year in the 5-year (or 7-year) period to 2 years after the due date of the return for the last year of the period. Free tax h&r block The period is extended only for deductions of the activity and any related deductions that might be affected. Free tax h&r block    You must file Form 5213 within 3 years after the due date of your return (determined without extensions) for the year in which you first carried on the activity, or, if earlier, within 60 days after receiving written notice from the Internal Revenue Service proposing to disallow deductions attributable to the activity. Free tax h&r block Gross Income Gross income from a not-for-profit activity includes the total of all gains from the sale, exchange, or other disposition of property, and all other gross receipts derived from the activity. Free tax h&r block Gross income from the activity also includes capital gains and rents received for the use of property which is held in connection with the activity. Free tax h&r block You can determine gross income from any not-for-profit activity by subtracting the cost of goods sold from your gross receipts. Free tax h&r block However, if you determine gross income by subtracting cost of goods sold from gross receipts, you must do so consistently, and in a manner that follows generally accepted methods of accounting. Free tax h&r block Limit on Deductions If your activity is not carried on for profit, take deductions in the following order and only to the extent stated in the three categories. Free tax h&r block If you are an individual, these deductions may be taken only if you itemize. Free tax h&r block These deductions may be taken on Schedule A (Form 1040). Free tax h&r block Category 1. Free tax h&r block   Deductions you can take for personal as well as for business activities are allowed in full. Free tax h&r block For individuals, all nonbusiness deductions, such as those for home mortgage interest, taxes, and casualty losses, belong in this category. Free tax h&r block Deduct them on the appropriate lines of Schedule A (Form 1040). Free tax h&r block For tax years beginning after December 31, 2008, you can deduct a casualty loss on property you own for personal use only to the extent it is more than $500 and exceeds 10% of your adjusted gross income (AGI). Free tax h&r block The 10% AGI limitation does not apply to net disaster losses resulting from federally declared disasters in 2008 and 2009, and individuals are allowed to claim the net disaster losses even if they do not itemize their deductions. Free tax h&r block The reduction amount returns to $100 for tax years beginning after December 31, 2009. Free tax h&r block See Publication 547 for more information on casualty losses. Free tax h&r block For the limits that apply to home mortgage interest, see Publication 936. Free tax h&r block Category 2. Free tax h&r block   Deductions that do not result in an adjustment to the basis of property are allowed next, but only to the extent your gross income from the activity is more than your deductions under the first category. Free tax h&r block Most business deductions, such as those for advertising, insurance premiums, interest, utilities, and wages, belong in this category. Free tax h&r block Category 3. Free tax h&r block   Business deductions that decrease the basis of property are allowed last, but only to the extent the gross income from the activity exceeds the deductions you take under the first two categories. Free tax h&r block Deductions for depreciation, amortization, and the part of a casualty loss an individual could not deduct in category (1) belong in this category. Free tax h&r block Where more than one asset is involved, allocate depreciation and these other deductions proportionally. Free tax h&r block    Individuals must claim the amounts in categories (2) and (3) as miscellaneous deductions on Schedule A (Form 1040). Free tax h&r block They are subject to the 2%-of-adjusted-gross-income limit. Free tax h&r block See Publication 529 for information on this limit. Free tax h&r block Example. Free tax h&r block Adriana is engaged in a not-for-profit activity. Free tax h&r block The income and expenses of the activity are as follows. Free tax h&r block Gross income $3,200 Subtract:     Real estate taxes $700   Home mortgage interest 900   Insurance 400   Utilities 700   Maintenance 200   Depreciation on an automobile 600   Depreciation on a machine 200 3,700 Loss $(500)   Adriana must limit her deductions to $3,200, the gross income she earned from the activity. Free tax h&r block The limit is reached in category (3), as follows. Free tax h&r block Limit on deduction $3,200 Category 1: Taxes and interest $1,600   Category 2: Insurance, utilities, and maintenance 1,300 2,900 Available for Category 3 $ 300   The $800 of depreciation is allocated between the automobile and machine as follows. Free tax h&r block $600 $800 x $300 = $225 depreciation for the automobile             $200 $800 x $300 = $75 depreciation for the machine The basis of each asset is reduced accordingly. Free tax h&r block Adriana includes the $3,200 of gross income on line 21 (other income) of Form 1040. Free tax h&r block The $1,600 for category (1) is deductible in full on the appropriate lines for taxes and interest on Schedule A (Form 1040). Free tax h&r block Adriana deducts the remaining $1,600 ($1,300 for category (2) and $300 for category (3)) as other miscellaneous deductions on Schedule A (Form 1040) subject to the 2%-of-adjusted-gross-income limit. Free tax h&r block Partnerships and S corporations. Free tax h&r block   If a partnership or S corporation carries on a not-for-profit activity, these limits apply at the partnership or S corporation level. Free tax h&r block They are reflected in the individual shareholder's or partner's distributive shares. Free tax h&r block More than one activity. Free tax h&r block   If you have several undertakings, each may be a separate activity or several undertakings may be combined. Free tax h&r block The following are the most significant facts and circumstances in making this determination. Free tax h&r block The degree of organizational and economic interrelationship of various undertakings. Free tax h&r block The business purpose that is (or might be) served by carrying on the various undertakings separately or together in a business or investment setting. Free tax h&r block The similarity of the undertakings. Free tax h&r block   The IRS will generally accept your characterization if it is supported by facts and circumstances. Free tax h&r block    If you are carrying on two or more different activities, keep the deductions and income from each one separate. Free tax h&r block Figure separately whether each is a not-for-profit activity. Free tax h&r block Then figure the limit on deductions and losses separately for each activity that is not for profit. Free tax h&r block Prev  Up  Next   Home   More Online Publications
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The Free Tax H&r Block

Free tax h&r block Publication 551 - Main Content Table of Contents Cost BasisStocks and Bonds Real Property Business Assets Allocating the Basis Adjusted BasisIncreases to Basis Decreases to Basis Adjustments to Basis Example Basis Other Than CostProperty Received for Services Taxable Exchanges Nontaxable Exchanges Property Transferred From a Spouse Property Received as a Gift Inherited Property Property Changed to Business or Rental Use How To Get Tax HelpLow Income Taxpayer Clinics (LITCs). Free tax h&r block Cost Basis The basis of property you buy is usually its cost. Free tax h&r block The cost is the amount you pay in cash, debt obligations, other property, or services. Free tax h&r block Your cost also includes amounts you pay for the following items. Free tax h&r block Sales tax, Freight, Installation and testing, Excise taxes, Legal and accounting fees (when they must be capitalized), Revenue stamps, Recording fees, and Real estate taxes (if assumed for the seller). Free tax h&r block  You may also have to capitalize (add to basis) certain other costs related to buying or producing property. Free tax h&r block Loans with low or no interest. Free tax h&r block   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 the amount considered to be unstated interest. Free tax h&r block You generally have unstated interest if your interest rate is less than the applicable federal rate. Free tax h&r block For more information, see Unstated Interest and Original Issue Discount in Publication 537. Free tax h&r block Purchase of a business. Free tax h&r block   When you purchase a trade or business, you generally purchase all assets used in the business operations, such as land, buildings, and machinery. Free tax h&r block Allocate the price among the various assets, including any section 197 intangibles. Free tax h&r block See Allocating the Basis, later. Free tax h&r block Stocks and Bonds The basis of stocks or bonds you buy is generally the purchase price plus any costs of purchase, such as commissions and recording or transfer fees. Free tax h&r block If you get stocks or bonds other than by purchase, your basis is usually determined by the fair market value (FMV) or the previous owner's adjusted basis of the stock. Free tax h&r block You must adjust the basis of stocks for certain events that occur after purchase. Free tax h&r block See Stocks and Bonds in chapter 4 of Publication 550 for more information on the basis of stock. Free tax h&r block Identifying stock or bonds sold. Free tax h&r block   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 stock or bonds. Free tax h&r block 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. Free tax h&r block For more information about identifying securities you sell, see Stocks and Bonds under Basis of Investment Property in chapter 4 of Publication 550. Free tax h&r block Mutual fund shares. Free tax h&r block   If you sell mutual fund shares acquired at different times and prices, you can choose to use an average basis. Free tax h&r block For more information, see Publication 550. Free tax h&r block Real Property Real property, also called real estate, is land and generally anything built on or attached to it. Free tax h&r block If you buy real property, certain fees and other expenses become part of your cost basis in the property. Free tax h&r block Real estate taxes. Free tax h&r block   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. Free tax h&r block You cannot deduct them as taxes. Free tax h&r block   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. Free tax h&r block Do not include that amount in the basis of the property. Free tax h&r block If you did not reimburse the seller, you must reduce your basis by the amount of those taxes. Free tax h&r block Settlement costs. Free tax h&r block   Your basis includes the settlement fees and closing costs for buying property. Free tax h&r block You cannot include in your basis the fees and costs for getting a loan on property. Free tax h&r block A fee for buying property is a cost that must be paid even if you bought the property for cash. Free tax h&r block   The following items are some of the settlement fees or closing costs you can include in the basis of your property. Free tax h&r block Abstract fees (abstract of title fees); Charges for installing utility services; Legal fees (including title search and preparation of the sales contract and deed); Recording fees; Surveys; 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. Free tax h&r block   Settlement costs do not include amounts placed in escrow for the future payment of items such as taxes and insurance. Free tax h&r block   The following items are some settlement fees and closing costs you cannot include in the basis of the property. Free tax h&r block Casualty insurance premiums. Free tax h&r block Rent for occupancy of the property before closing. Free tax h&r block Charges for utilities or other services related to occupancy of the property before closing. Free tax h&r block Charges connected with getting a loan. Free tax h&r block The following are examples of these charges. Free tax h&r block Points (discount points, loan origination fees). Free tax h&r block Mortgage insurance premiums. Free tax h&r block Loan assumption fees. Free tax h&r block Cost of a credit report. Free tax h&r block Fees for an appraisal required by a lender. Free tax h&r block Fees for refinancing a mortgage. Free tax h&r block If these costs relate to business property, items (1) through (3) are deductible as business expenses. Free tax h&r block Items (4) and (5) must be capitalized as costs of getting a loan and can be deducted over the period of the loan. Free tax h&r block Points. Free tax h&r block   If you pay points to obtain 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. Free tax h&r block Generally, you deduct the points over the term of the loan. Free tax h&r block For more information on how to deduct points, see Points in chapter 4 of Publication 535. Free tax h&r block Points on home mortgage. Free tax h&r block   Special rules may apply to points you and the seller pay when you obtain a mortgage to purchase your main home. Free tax h&r block If certain requirements are met, you can deduct the points in full for the year in which they are paid. Free tax h&r block Reduce the basis of your home by any seller-paid points. Free tax h&r block For more information, see Points in Publication 936, Home Mortgage Interest Deduction. Free tax h&r block Assumption of mortgage. Free tax h&r block   If you buy property and assume (or buy 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. Free tax h&r block Example. Free tax h&r block If you buy a building for $20,000 cash and assume a mortgage of $80,000 on it, your basis is $100,000. Free tax h&r block Constructing assets. Free tax h&r block   If you build property or have assets built for you, your expenses for this construction are part of your basis. Free tax h&r block Some of these expenses include the following costs. Free tax h&r block Land, Labor and materials, Architect's fees, Building permit charges, Payments to contractors, Payments for rental equipment, and Inspection fees. Free tax h&r block In addition, if you own a business and use your employees, material, and equipment to build an asset, do not deduct the following expenses. Free tax h&r block You must include them in the asset's basis. Free tax h&r block Employee wages paid for the construction work, reduced by any employment credits allowed; Depreciation on equipment you own while it is used in the construction; Operating and maintenance costs for equipment used in the construction; and The cost of business supplies and materials used in the construction. Free tax h&r block    Do not include the value of your own labor, or any other labor you did not pay for, in the basis of any property you construct. Free tax h&r block Business Assets If you purchase property to use in your business, your basis is usually its actual cost to you. Free tax h&r block If you construct, create, or otherwise produce property, you must capitalize the costs as your basis. Free tax h&r block In certain circumstances, you may be subject to the uniform capitalization rules, next. Free tax h&r block Uniform Capitalization Rules The uniform capitalization rules specify the costs you add to basis in certain circumstances. Free tax h&r block Activities subject to the rules. Free tax h&r block   You must use the uniform capitalization rules if you do any of the following in your trade or business or activity carried on for profit. Free tax h&r block Produce real or tangible personal property for use in the business or activity, Produce real or tangible personal property for sale to customers, or Acquire property for resale. Free tax h&r block However, this rule does not apply to personal property if your average annual gross receipts for the 3 previous tax years are $10 million or less. Free tax h&r block   You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow the property. Free tax h&r block Treat property produced for you under a contract as produced by you up to the amount you pay or costs you otherwise incur for the property. Free tax h&r block Tangible personal property includes films, sound recordings, video tapes, books, or similar property. Free tax h&r block    Under the uniform capitalization rules, you must capitalize all direct costs and an allocable part of most indirect costs you incur due to your production or resale activities. Free tax h&r block To capitalize means to include certain expenses in the basis of property you produce or in your inventory costs rather than deduct them as a current expense. Free tax h&r block You recover these costs through deductions for depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property. Free tax h&r block   Any cost you cannot use to figure your taxable income for any tax year is not subject to the uniform capitalization rules. Free tax h&r block Example. Free tax h&r block If you incur a business meal expense for which your deduction would be limited to 50% of the cost of the meal, that amount is subject to the uniform capitalization rules. Free tax h&r block The nondeductible part of the cost is not subject to the uniform capitalization rules. Free tax h&r block More information. Free tax h&r block   For more information about these rules, see the regulations under section 263A of the Internal Revenue Code and Publication 538, Accounting Periods and Methods. Free tax h&r block Exceptions. Free tax h&r block   The following are not subject to the uniform capitalization rules. Free tax h&r block Property you produce that you do not use in your trade, business, or activity conducted for profit; Qualified creative expenses you pay or incur as a free-lance (self-employed) writer, photographer, or artist that are otherwise deductible on your tax return; Property you produce under a long-term contract, except for certain home construction contracts; Research and experimental expenses deductible under section 174 of the Internal Revenue Code; and Costs for personal property acquired for resale if your (or your predecessor's) average annual gross receipts for the 3 previous tax years do not exceed $10 million. Free tax h&r block For other exceptions to the uniform capitalization rules, see section 1. Free tax h&r block 263A-1(b) of the regulations. Free tax h&r block   For information on the special rules that apply to costs incurred in the business of farming, see chapter 6 of Publication 225, Farmer's Tax Guide. Free tax h&r block Intangible Assets Intangible assets include goodwill, patents, copyrights, trademarks, trade names, and franchises. Free tax h&r block The basis of an intangible asset is usually the cost to buy or create it. Free tax h&r block If you acquire multiple assets, for example a going business for a lump sum, see Allocating the Basis below to figure the basis of the individual assets. Free tax h&r block The basis of certain intangibles can be amortized. Free tax h&r block See chapter 8 of Publication 535 for information on the amortization of these costs. Free tax h&r block Patents. Free tax h&r block   The basis of a patent you get for an invention is the cost of development, such as research and experimental expenditures, drawings, working models, and attorneys' and governmental fees. Free tax h&r block If you deduct the research and experimental expenditures as current business expenses, you cannot include them in the basis of the patent. Free tax h&r block The value of the inventor's time spent on an invention is not part of the basis. Free tax h&r block Copyrights. Free tax h&r block   If you are an author, the basis of a copyright will usually be the cost of getting the copyright plus copyright fees, attorneys' fees, clerical assistance, and the cost of plates that remain in your possession. Free tax h&r block Do not include the value of your time as the author, or any other person's time you did not pay for. Free tax h&r block Franchises, trademarks, and trade names. Free tax h&r block   If you buy a franchise, trademark, or trade name, the basis is its cost, unless you can deduct your payments as a business expense. Free tax h&r block Allocating the Basis If you buy multiple assets for a lump sum, allocate the amount you pay among the assets you receive. Free tax h&r block You must make this allocation to figure your basis for depreciation and gain or loss on a later disposition of any of these assets. Free tax h&r block See Trade or Business Acquired below. Free tax h&r block Group of Assets Acquired If you buy multiple assets for a lump sum, you and the seller may agree to a specific allocation of the purchase price among the assets in the sales contract. Free tax h&r block If this allocation is based on the value of each asset and you and the seller have adverse tax interests, the allocation generally will be accepted. Free tax h&r block However, see Trade or Business Acquired, next. Free tax h&r block Trade or Business Acquired If you acquire a trade or business, allocate the consideration paid to the various assets acquired. Free tax h&r block Generally, reduce the consideration paid by any cash and general deposit accounts (including checking and savings accounts) received. Free tax h&r block Allocate the remaining consideration to the other business assets received in proportion to (but not more than) their fair market value in the following order. Free tax h&r block Certificates of deposit, U. Free tax h&r block S. Free tax h&r block Government securities, foreign currency, and actively traded personal property, including stock and securities. Free tax h&r block Accounts receivable, other debt instruments, and assets you mark to market at least annually for federal income tax purposes. Free tax h&r block Property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held primarily for sale to customers in the ordinary course of business. Free tax h&r block All other assets except section 197 intangibles, goodwill, and going concern value. Free tax h&r block Section 197 intangibles except goodwill and going concern value. Free tax h&r block Goodwill and going concern value (whether or not they qualify as section 197 intangibles). Free tax h&r block Agreement. Free tax h&r block   The buyer and seller may enter into a written agreement as to the allocation of any consideration or the fair market value (FMV) of any of the assets. Free tax h&r block This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. Free tax h&r block Reporting requirement. Free tax h&r block   Both the buyer and seller involved in the sale of business assets must report to the IRS the allocation of the sales price among section 197 intangibles and the other business assets. Free tax h&r block Use Form 8594 to provide this information. Free tax h&r block The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. Free tax h&r block More information. Free tax h&r block   See Sale of a Business in chapter 2 of Publication 544 for more information. Free tax h&r block Land and Buildings If you buy buildings and the land on which they stand for a lump sum, allocate the basis of the property among the land and the buildings so you can figure the depreciation allowable on the buildings. Free tax h&r block Figure the basis of each asset by multiplying the lump sum by a fraction. Free tax h&r block The numerator is the FMV of that asset and the denominator is the FMV of the whole property at the time of purchase. Free tax h&r block If you are not certain of the FMV of the land and buildings, you can allocate the basis based on their assessed values for real estate tax purposes. Free tax h&r block Demolition of building. Free tax h&r block   Add demolition costs and other losses incurred for the demolition of any building to the basis of the land on which the demolished building was located. Free tax h&r block Do not claim the costs as a current deduction. Free tax h&r block Modification of building. Free tax h&r block   A modification of a building will not be treated as a demolition if the following conditions are satisfied. Free tax h&r block 75 percent or more of the existing external walls of the building are retained in place as internal or external walls, and 75 percent or more of the existing internal structural framework of the building is retained in place. Free tax h&r block   If the building is a certified historic structure, the modification must also be part of a certified rehabilitation. Free tax h&r block   If these conditions are met, add the costs of the modifications to the basis of the building. Free tax h&r block Subdivided lots. Free tax h&r block   If you buy a tract of land and subdivide it, you must determine the basis of each lot. Free tax h&r block This is necessary because you must figure the gain or loss on the sale of each individual lot. Free tax h&r block As a result, you do not recover your entire cost in the tract until you have sold all of the lots. Free tax h&r block   To determine the basis of an individual lot, multiply the total cost of the tract by a fraction. Free tax h&r block The numerator is the FMV of the lot and the denominator is the FMV of the entire tract. Free tax h&r block Future improvement costs. Free tax h&r block   If you are a developer and sell subdivided lots before the development work is completed, you can (with IRS consent) include in the basis of the properties sold an allocation of the estimated future cost for common improvements. Free tax h&r block See Revenue Procedure 92–29 for more information, including an explanation of the procedures for getting consent from the IRS. Free tax h&r block Use of erroneous cost basis. Free tax h&r block   If you made a mistake in figuring the cost basis of subdivided lots sold in previous years, you cannot correct the mistake for years for which the statute of limitations (generally 3 tax years) has expired. Free tax h&r block Figure the basis of any remaining lots by allocating the correct original cost basis of the entire tract among the original lots. Free tax h&r block Example. Free tax h&r block You bought a tract of land to which you assigned a cost of $15,000. Free tax h&r block You subdivided the land into 15 building lots of equal size and equitably divided your basis so that each lot had a basis of $1,000. Free tax h&r block You treated the sale of each lot as a separate transaction and figured gain or loss separately on each sale. Free tax h&r block Several years later you determine that your original basis in the tract was $22,500 and not $15,000. Free tax h&r block You sold eight lots using $8,000 of basis in years for which the statute of limitations has expired. Free tax h&r block You now can take $1,500 of basis into account for figuring gain or loss only on the sale of each of the remaining seven lots ($22,500 basis divided among all 15 lots). Free tax h&r block You cannot refigure the basis of the eight lots sold in tax years barred by the statute of limitations. Free tax h&r block 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 to the basis of the property. Free tax h&r block The result of these adjustments to the basis is the adjusted basis. Free tax h&r block Increases to Basis Increase the basis of any property by all items properly added to a capital account. Free tax h&r block These include the cost of any improvements having a useful life of more than 1 year. Free tax h&r block Rehabilitation expenses also increase basis. Free tax h&r block However, you must subtract any rehabilitation credit allowed for these expenses before you add them to your basis. Free tax h&r block If you have to recapture any of the credit, increase your basis by the recaptured amount. Free tax h&r block If you make additions or improvements to business property, keep separate accounts for them. Free tax h&r block Also, you must depreciate the basis of each according to the depreciation rules that would apply to the underlying property if you had placed it in service at the same time you placed the addition or improvement in service. Free tax h&r block For more information, see Publication 946. Free tax h&r block The following items increase the basis of property. Free tax h&r block The cost of extending utility service lines to the property; Impact fees; Legal fees, such as the cost of defending and perfecting title; Legal fees for obtaining a decrease in an assessment levied against property to pay for local improvements; Zoning costs; and The capitalized value of a redeemable ground rent. Free tax h&r block Assessments for Local Improvements Increase the basis of property by assessments for items such as paving roads and building ditches that increase the value of the property assessed. Free tax h&r block Do not deduct them as taxes. Free tax h&r block However, you can deduct as taxes charges for maintenance, repairs, or interest charges related to the improvements. Free tax h&r block Example. Free tax h&r block Your city changes the street in front of your store into an enclosed pedestrian mall and assesses you and other affected landowners for the cost of the conversion. Free tax h&r block Add the assessment to your property's basis. Free tax h&r block In this example, the assessment is a depreciable asset. Free tax h&r block Deducting vs. Free tax h&r block Capitalizing Costs Do not add to your basis costs you can deduct as current expenses. Free tax h&r block For example, amounts paid for incidental repairs or maintenance that are deductible as business expenses cannot be added to basis. Free tax h&r block However, you can choose either to deduct or to capitalize certain other costs. Free tax h&r block If you capitalize these costs, include them in your basis. Free tax h&r block If you deduct them, do not include them in your basis. Free tax h&r block See Uniform Capitalization Rules earlier. Free tax h&r block The costs you can choose to deduct or to capitalize include the following. Free tax h&r block Carrying charges, such as interest and taxes, that you pay to own property, except carrying charges that must be capitalized under the uniform capitalization rules; Research and experimentation costs; Intangible drilling and development costs for oil, gas, and geothermal wells; Exploration costs for new mineral deposits; Mining development costs for a new mineral deposit; Costs of establishing, maintaining, or increasing the circulation of a newspaper or other periodical; and Costs of removing architectural and transportation barriers to people with disabilities and the elderly. Free tax h&r block If you claim the disabled access credit, you must reduce the amount you deduct or capitalize by the amount of the credit. Free tax h&r block For more information about deducting or capitalizing costs, see chapter 7 in Publication 535. Free tax h&r block Table 1. Free tax h&r block Examples of Increases and Decreases to Basis Increases to Basis Decreases to Basis Capital improvements:   Putting an addition on your home   Replacing an entire roof  Paving your driveway  Installing central air conditioning Rewiring your home Exclusion from income of subsidies for energy conservation measures  Casualty or theft loss deductions and insurance reimbursements  Vehicle credits Assessments for local improvements: Water connections Sidewalks Roads Section 179 deduction  Casualty losses: Restoring damaged property Depreciation  Nontaxable corporate distributions Legal fees:  Cost of defending and perfecting a title   Zoning costs   Decreases to Basis The following are some items that reduce the basis of property. Free tax h&r block Section 179 deduction; Nontaxable corporate distributions; Deductions previously allowed (or allowable) for amortization, depreciation, and depletion; Exclusion of subsidies for energy conservation measures; Vehicle credits; Residential energy credits; Postponed gain from sale of home; Investment credit (part or all) taken; Casualty and theft losses and insurance reimbursement; Certain canceled debt excluded from income; Rebates from a manufacturer or seller; Easements; Gas-guzzler tax; Adoption tax benefits; and Credit for employer-provided child care. Free tax h&r block Some of these items are discussed next. Free tax h&r block Casualties and Thefts If you have a casualty or theft loss, decrease the basis in your property by any insurance or other reimbursement and by any deductible loss not covered by insurance. Free tax h&r block 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. Free tax h&r block To make this determination, compare the repaired property to the property before the casualty. Free tax h&r block For more information on casualty and theft losses, see Publication 547, Casualties, Disasters, and Thefts. Free tax h&r block Easements The amount you receive for granting an easement is generally considered to be a sale of an interest in real property. Free tax h&r block It reduces the basis of the affected part of the property. Free tax h&r block 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. Free tax h&r block Vehicle Credits Unless you elect not to claim the qualified plug-in electric vehicle credit, the alternative motor vehicle credit, or the qualified plug-in electric drive motor vehicle credit, you may have to reduce the basis of each qualified vehicle by certain amounts reported. Free tax h&r block For more information, see Form 8834, Qualified Plug-in Electric and Electric Vehicle Credit; Form 8910, Alternative Motor Vehicle Credit; Form 8936, Qualified Plug-in Electric Drive Motor Vehicle Credit;and the related instructions. Free tax h&r block Gas-Guzzler Tax Decrease the basis in your car by the gas-guzzler (fuel economy) tax if you begin using the car within 1 year of the date of its first sale for ultimate use. Free tax h&r block This rule also applies to someone who later buys the car and begins using it not more than 1 year after the original sale for ultimate use. Free tax h&r block If the car is imported, the one-year period begins on the date of entry or withdrawal of the car from the warehouse if that date is later than the date of the first sale for ultimate use. Free tax h&r block Section 179 Deduction If you take the section 179 deduction for all or part of the cost of qualifying business property, decrease the basis of the property by the deduction. Free tax h&r block For more information about the section 179 deduction, see Publication 946. Free tax h&r block 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 any energy conservation measure for a dwelling unit. Free tax h&r block Reduce the basis of the property for which you received the subsidy by the excluded amount. Free tax h&r block For more information on this subsidy, see Publication 525. Free tax h&r block Depreciation Decrease the basis of property by the depreciation you deducted, or could have deducted, on your tax returns under the method of depreciation you chose. Free tax h&r block If you took less depreciation than you could have under the method chosen, decrease the basis by the amount you could have taken under that method. Free tax h&r block If you did not take a depreciation deduction, reduce the basis by the full amount of the depreciation you could have taken. Free tax h&r block Unless a timely election is made not to deduct the special depreciation allowance for property placed in service after September 10, 2001, decrease the property's basis by the special depreciation allowance you deducted or could have deducted. Free tax h&r block If you deducted more depreciation than you should have, decrease your basis by the amount equal to the depreciation you should have deducted plus the part of the excess depreciation you deducted that actually reduced your tax liability for the year. Free tax h&r block In decreasing your basis for depreciation, take into account the amount deducted on your tax returns as depreciation and any depreciation capitalized under the uniform capitalization rules. Free tax h&r block For information on figuring depreciation, see Publication 946. Free tax h&r block If you are claiming depreciation on a business vehicle, see Publication 463. Free tax h&r block If the car is not used more than 50% for business during the tax year, you may have to recapture excess depreciation. Free tax h&r block Include the excess depreciation in your gross income and add it to your basis in the property. Free tax h&r block For information on the computation of excess depreciation, see chapter 4 in Publication 463. Free tax h&r block Canceled Debt Excluded From Income If a debt you owe is canceled or forgiven, other than as a gift or bequest, you generally must include the canceled amount in your gross income for tax purposes. Free tax h&r block A debt includes any indebtedness for which you are liable or which attaches to property you hold. Free tax h&r block You can exclude canceled debt from income in the following situations. Free tax h&r block Debt canceled in a bankruptcy case or when you are insolvent, Qualified farm debt, and Qualified real property business debt (provided you are not a C corporation). Free tax h&r block If you exclude from income canceled debt under situation (1) or (2), you may have to reduce the basis of your depreciable and nondepreciable property. Free tax h&r block However, in situation (3), you must reduce the basis of your depreciable property by the excluded amount. Free tax h&r block For more information about canceled debt in a bankruptcy case or during insolvency, see Publication 908, Bankruptcy Tax Guide. Free tax h&r block For more information about canceled debt that is qualified farm debt, see chapter 3 in Publication 225. Free tax h&r block For more information about qualified real property business debt, see chapter 5 in Publication 334, Tax Guide for Small Business. Free tax h&r block Postponed Gain From Sale of Home If you postponed gain from the sale of your main home before May 7, 1997, you must reduce the basis of your new home by the postponed gain. Free tax h&r block For more information on the rules for the sale of a home, see Publication 523. Free tax h&r block Adoption Tax Benefits If you claim an adoption credit for the cost of improvements you added to the basis of your home, decrease the basis of your home by the credit allowed. Free tax h&r block This also applies to amounts you received under an employer's adoption assistance program and excluded from income. Free tax h&r block For more information Form 8839, Qualified Adoption Expenses. Free tax h&r block Employer-Provided Child Care If you are an employer, you can claim the employer-provided child care credit on amounts you paid or incurred to acquire, construct, rehabilitate, or expand property used as part of your qualified child care facility. Free tax h&r block You must reduce your basis in that property by the credit claimed. Free tax h&r block For more information, see Form 8882, Credit for Employer-Provided Child Care Facilities and Services. Free tax h&r block Adjustments to Basis Example In January 2005, you paid $80,000 for real property to be used as a factory. Free tax h&r block You also paid commissions of $2,000 and title search and legal fees of $600. Free tax h&r block You allocated the total cost of $82,600 between the land and the building—$10,325 for the land and $72,275 for the building. Free tax h&r block Immediately you spent $20,000 in remodeling the building before you placed it in service. Free tax h&r block You were allowed depreciation of $14,526 for the years 2005 through 2009. Free tax h&r block In 2008 you had a $5,000 casualty loss from a that was not covered by insurance on the building. Free tax h&r block You claimed a deduction for this loss. Free tax h&r block You spent $5,500 to repair the damages and extend the useful life of the building. Free tax h&r block The adjusted basis of the building on January 1, 2010, is figured as follows: Original cost of building including fees and commissions $72,275 Adjustments to basis:     Add:         Improvements 20,000   Repair of damages 5,500       $97,775 Subtract:       Depreciation $14,526     Deducted casualty loss 5,000 19,526 Adjusted basis on January 1, 2010 $78,249 The basis of the land, $10,325, remains unchanged. Free tax h&r block It is not affected by any of the above adjustments. Free tax h&r block Basis Other Than Cost There are many times when you cannot use cost as basis. Free tax h&r block In these cases, the fair market value or the adjusted basis of property may be used. Free tax h&r block Adjusted basis is discussed earlier. Free tax h&r block Fair market value (FMV). Free tax h&r block   FMV is the price at which property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts. Free tax h&r block Sales of similar property on or about the same date may be helpful in figuring the property's FMV. Free tax h&r block Property Received for Services If you receive property for services, include the property's FMV in income. Free tax h&r block The amount you include in income becomes your basis. Free tax h&r block 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. Free tax h&r block Bargain Purchases A bargain purchase is a purchase of an item for less than its FMV. Free tax h&r block If, as compensation for services, you purchase goods or other property at less than FMV, include the difference between the purchase price and the property's FMV in your income. Free tax h&r block Your basis in the property is its FMV (your purchase price plus the amount you include in income). Free tax h&r block If the difference between your purchase price and the FMV represents a qualified employee discount, do not include the difference in income. Free tax h&r block However, your basis in the property is still its FMV. Free tax h&r block See Employee Discounts in Publication 15-B. Free tax h&r block 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 unless you make the election discussed later. Free tax h&r block Property becomes substantially vested when your rights in the property or the rights of any person to whom you transfer the property are not subject to a substantial risk of forfeiture. Free tax h&r block There is substantial risk of forfeiture when the rights to full enjoyment of the property depend on the future performance of substantial services by any person. Free tax h&r block When the property becomes substantially vested, include the FMV, less any amount you paid for the property, in income. Free tax h&r block Example. Free tax h&r block Your employer gives you stock for services performed under the condition that you will have to return the stock unless you complete 5 years of service. Free tax h&r block The stock is under a substantial risk of forfeiture and is not substantially vested when you receive it. Free tax h&r block You do not report any income until you have completed the 5 years of service that satisfy the condition. Free tax h&r block Fair market value. Free tax h&r block   Figure the FMV of property you received without considering any restriction except one that by its terms will never end. Free tax h&r block Example. Free tax h&r block You received stock from your employer for services you performed. Free tax h&r block If you want to sell the stock while you are still employed, you must sell the stock to your employer at book value. Free tax h&r block At your retirement or death, you or your estate must offer to sell the stock to your employer at its book value. Free tax h&r block This is a restriction that by its terms will never end and you must consider it when you figure the FMV. Free tax h&r block Election. Free tax h&r block   You can choose to include in your gross income the FMV of the property at the time of transfer, less any amount you paid for it. Free tax h&r block If you make this choice, the substantially vested rules do not apply. Free tax h&r block Your basis is the amount you paid plus the amount you included in income. Free tax h&r block   See the discussion of Restricted Property in Publication 525 for more information. Free tax h&r block Taxable Exchanges A taxable exchange is one in which the gain is taxable or the loss is deductible. Free tax h&r block A taxable gain or deductible loss is also known as a recognized gain or loss. Free tax h&r block If you receive property in exchange for other property in a taxable exchange, the basis of property you receive is usually its FMV at the time of the exchange. Free tax h&r block A taxable exchange occurs when you receive cash or property not similar or related in use to the property exchanged. Free tax h&r block Example. Free tax h&r block You trade a tract of farm land with an adjusted basis of $3,000 for a tractor that has an FMV of $6,000. Free tax h&r block You must report a taxable gain of $3,000 for the land. Free tax h&r block The tractor has a basis of $6,000. Free tax h&r block Involuntary Conversions If you receive property as a result of an involuntary conversion, such as a casualty, theft, or condemnation, you can figure the basis of the replacement property you receive using the basis of the converted property. Free tax h&r block Similar or related property. Free tax h&r block   If you receive replacement property similar or related in service or use to the converted property, the replacement property's basis is the old property's basis on the date of the conversion. Free tax h&r block However, make the following adjustments. Free tax h&r block Decrease the basis by the following. Free tax h&r block Any loss you recognize on the conversion, and Any money you receive that you do not spend on similar property. Free tax h&r block Increase the basis by the following. Free tax h&r block Any gain you recognize on the conversion, and Any cost of acquiring the replacement property. Free tax h&r block Money or property not similar or related. Free tax h&r block   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 new property is its cost decreased by the gain not recognized on the conversion. Free tax h&r block Example. Free tax h&r block The state condemned your property. Free tax h&r block The property had an adjusted basis of $26,000 and the state paid you $31,000 for it. Free tax h&r block You realized a gain of $5,000 ($31,000 − $26,000). Free tax h&r block You bought replacement property similar in use to the converted property for $29,000. Free tax h&r block You recognize a gain of $2,000 ($31,000 − $29,000), the unspent part of the payment from the state. Free tax h&r block Your gain not recognized is $3,000, the difference between the $5,000 realized gain and the $2,000 recognized gain. Free tax h&r block The basis of the new property is figured as follows: Cost of replacement property $29,000 Minus: Gain not recognized 3,000 Basis of the replacement property $26,000 Allocating the basis. Free tax h&r block   If you buy more than one piece of replacement property, allocate your basis among the properties based on their respective costs. Free tax h&r block Example. Free tax h&r block The state in the previous example condemned your unimproved real property and the replacement property you bought was improved real property with both land and buildings. Free tax h&r block Allocate the replacement property's $26,000 basis between land and buildings based on their respective costs. Free tax h&r block More information. Free tax h&r block   For more information about condemnations, see Involuntary Conversions in Publication 544. Free tax h&r block For more information about casualty and theft losses, see Publication 547. Free tax h&r block Nontaxable Exchanges A nontaxable exchange is an exchange in which you are not taxed on any gain and you cannot deduct any loss. Free tax h&r block If you receive property in a nontaxable exchange, its basis is usually the same as the basis of the property you transferred. Free tax h&r block A nontaxable gain or loss is also known as an unrecognized gain or loss. Free tax h&r block Like-Kind Exchanges The exchange of property for the same kind of property is the most common type of nontaxable exchange. Free tax h&r block To qualify as a like-kind exchange, you must hold for business or investment purposes both the property you transfer and the property you receive. Free tax h&r block There must also be an exchange of like-kind property. Free tax h&r block For more information, see Like-Kind Exchanges in Publication 544. Free tax h&r block The basis of the property you receive is the same as the basis of the property you gave up. Free tax h&r block Example. Free tax h&r block You exchange real estate (adjusted basis $50,000, FMV $80,000) held for investment for other real estate (FMV $80,000) held for investment. Free tax h&r block Your basis in the new property is the same as the basis of the old ($50,000). Free tax h&r block Exchange expenses. Free tax h&r block   Exchange expenses are generally the closing costs you pay. Free tax h&r block They include such items as brokerage commissions, attorney fees, deed preparation fees, etc. Free tax h&r block Add them to the basis of the like-kind property received. Free tax h&r block Property plus cash. Free tax h&r block   If you trade property in a like-kind exchange and also pay money, the basis of the property received is the basis of the property you gave up increased by the money you paid. Free tax h&r block Example. Free tax h&r block You trade in a truck (adjusted basis $3,000) for another truck (FMV $7,500) and pay $4,000. Free tax h&r block Your basis in the new truck is $7,000 (the $3,000 basis of the old truck plus the $4,000 paid). Free tax h&r block Special rules for related persons. Free tax h&r block   If a like-kind exchange takes place directly or indirectly between related persons and either party disposes of the property within 2 years after the exchange, the exchange no longer qualifies for like-kind exchange treatment. Free tax h&r block Each person must report any gain or loss not recognized on the original exchange. Free tax h&r block Each person reports it on the tax return filed for the year in which the later disposition occurs. Free tax h&r block If this rule applies, the basis of the property received in the original exchange will be its fair market value. Free tax h&r block   These rules generally do not apply to the following kinds of property dispositions. Free tax h&r block Dispositions due to the death of either related person, Involuntary conversions, and Dispositions in which neither the original exchange nor the subsequent disposition had as a main purpose the avoidance of federal income tax. Free tax h&r block Related persons. Free tax h&r block   Generally, related persons are ancestors, lineal descendants, brothers and sisters (whole or half), and a spouse. Free tax h&r block   For other related persons (for example, two corporations, an individual and a corporation, a grantor and fiduciary, etc. Free tax h&r block ), see Nondeductible Loss in chapter 2 of Publication 544. Free tax h&r block Exchange of business property. Free tax h&r block   Exchanging the assets of one business for the assets of another business is a multiple property exchange. Free tax h&r block For information on figuring basis, see Multiple Property Exchanges in chapter 1 of Publication 544. Free tax h&r block Partially Nontaxable Exchange A partially nontaxable exchange is an exchange in which you receive unlike property or money in addition to like property. Free tax h&r block The basis of the property you receive is the same as the basis of the property you gave up, with the following adjustments. Free tax h&r block Decrease the basis by the following amounts. Free tax h&r block Any money you receive, and Any loss you recognize on the exchange. Free tax h&r block Increase the basis by the following amounts. Free tax h&r block Any additional costs you incur, and Any gain you recognize on the exchange. Free tax h&r block If the other party to the exchange assumes your liabilities, treat the debt assumption as money you received in the exchange. Free tax h&r block Example. Free tax h&r block You traded a truck (adjusted basis $6,000) for a new truck (FMV $5,200) and $1,000 cash. Free tax h&r block You realized a gain of $200 ($6,200 − $6,000). Free tax h&r block This is the FMV of the truck received plus the cash minus the adjusted basis of the truck you traded ($5,200 + $1,000 – $6,000). Free tax h&r block You include all the gain in income (recognized gain) because the gain is less than the cash received. Free tax h&r block Your basis in the new truck is: Adjusted basis of old truck $6,000 Minus: Cash received (adjustment 1(a)) 1,000   $5,000 Plus: Gain recognized (adjustment 2(b)) 200 Basis of new truck $5,200 Allocation of basis. Free tax h&r block   Allocate the basis first to the unlike property, other than money, up to its FMV on the date of the exchange. Free tax h&r block The rest is the basis of the like property. Free tax h&r block Example. Free tax h&r block You had an adjusted basis of $15,000 in real estate you held for investment. Free tax h&r block You exchanged it for other real estate to be held for investment with an FMV of $12,500, a truck with an FMV of $3,000, and $1,000 cash. Free tax h&r block The truck is unlike property. Free tax h&r block You realized a gain of $1,500 ($16,500 − $15,000). Free tax h&r block This is the FMV of the real estate received plus the FMV of the truck received plus the cash minus the adjusted basis of the real estate you traded ($12,500 + $3,000 + $1,000 – $15,000). Free tax h&r block You include in income (recognize) all $1,500 of the gain because it is less than the FMV of the unlike property plus the cash received. Free tax h&r block Your basis in the properties you received is figured as follows. Free tax h&r block Adjusted basis of real estate transferred $15,000 Minus: Cash received (adjustment 1(a)) 1,000   $14,000 Plus: Gain recognized (adjustment 2(b)) 1,500 Total basis of properties received $15,500 Allocate the total basis of $15,500 first to the unlike property — the truck ($3,000). Free tax h&r block This is the truck's FMV. Free tax h&r block The rest ($12,500) is the basis of the real estate. Free tax h&r block Sale and Purchase If you sell property and buy similar property in two mutually dependent transactions, you may have to treat the sale and purchase as a single nontaxable exchange. Free tax h&r block Example. Free tax h&r block You are a salesperson and you use one of your cars 100% for business. Free tax h&r block You have used this car in your sales activities for 2 years and have depreciated it. Free tax h&r block Your adjusted basis in the car is $22,600 and its FMV is $23,100. Free tax h&r block You are interested in a new car, which sells for $28,000. Free tax h&r block If you trade your old car and pay $4,900 for the new one, your basis for depreciation for the new car would be $27,500 ($4,900 plus the $22,600 basis of your old car). Free tax h&r block However, you want a higher basis for depreciating the new car, so you agree to pay the dealer $28,000 for the new car if he will pay you $23,100 for your old car. Free tax h&r block Because the two transactions are dependent on each other, you are treated as having exchanged your old car for the new one and paid $4,900 ($28,000 − $23,100). Free tax h&r block Your basis for depreciating the new car is $27,500, the same as if you traded the old car. Free tax h&r block Partial Business Use of Property If you have property used partly for business and partly for personal use, and you exchange it in a nontaxable exchange for property to be used wholly or partly in your business, the basis of the property you receive is figured as if you had exchanged two properties. Free tax h&r block The first is an exchange of like-kind property. Free tax h&r block The second is personal-use property on which gain is recognized and loss is not recognized. Free tax h&r block First, figure your adjusted basis in the property as if you transferred two separate properties. Free tax h&r block Figure the adjusted basis of each part of the property by taking into account any adjustments to basis. Free tax h&r block Deduct the depreciation you took or could have taken from the adjusted basis of the business part. Free tax h&r block Then figure the amount realized for your property and allocate it to the business and nonbusiness parts of the property. Free tax h&r block The business part of the property is permitted to be exchanged tax free. Free tax h&r block However, you must recognize any gain from the exchange of the nonbusiness part. Free tax h&r block You are deemed to have received, in exchange for the nonbusiness part, an amount equal to its FMV on the date of the exchange. Free tax h&r block The basis of the property you acquired is the total basis of the property transferred (adjusted to the date of the exchange), increased by any gain recognized on the nonbusiness part. Free tax h&r block If the nonbusiness part of the property transferred is your main home, you may qualify to exclude from income all or part of the gain on that part. Free tax h&r block For more information, see Publication 523. Free tax h&r block Trade of car used partly in business. Free tax h&r block   If you trade in a car you used partly in your business for another car you will use in your business, your basis for depreciation of the new car is not the same as your basis for figuring a gain or loss on its sale. Free tax h&r block   For information on figuring your basis for depreciation, see Publication 463. Free tax h&r block Property Transferred From a Spouse The basis of property transferred to you or transferred in trust for your benefit by your spouse (or former spouse if the transfer is incident to divorce), is the same as your spouse's adjusted basis. Free tax h&r block However, adjust your basis for any gain recognized by your spouse or former spouse on property transferred in trust. Free tax h&r block This rule applies only to a transfer of property in trust in which the liabilities assumed, plus the liabilities to which the property is subject, are more than the adjusted basis of the property transferred. Free tax h&r block If the property transferred to you is a series E, series EE, or series I United States savings bond, the transferor must include in income the interest accrued to the date of transfer. Free tax h&r block 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. Free tax h&r block For more information on these bonds, see Publication 550. Free tax h&r block At the time of the transfer, the transferor must give you the records necessary to determine the adjusted basis and holding period of the property as of the date of transfer. Free tax h&r block For more information, see Publication 504, Divorced or Separated Individuals. Free tax h&r block Property Received as a Gift To figure the basis of property you receive as a gift, you must know its adjusted basis (defined earlier) 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. Free tax h&r block 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. Free tax h&r block Your basis for figuring gain is the same as the donor's adjusted basis plus or minus any required adjustment to basis while you held the property. Free tax h&r block Your basis for figuring loss is its FMV when you received the gift plus or minus any required adjustment to basis while you held the property (see Adjusted Basis earlier). Free tax h&r block If you use the donor's adjusted basis for figuring a gain and get a loss, and then use the FMV for figuring a loss and have a gain, you have neither gain nor loss on the sale or disposition of the property. Free tax h&r block Example. Free tax h&r block You received an acre of land as a gift. Free tax h&r block At the time of the gift, the land had an FMV of $8,000. Free tax h&r block The donor's adjusted basis was $10,000. Free tax h&r block After you received the land, no events occurred to increase or decrease your basis. Free tax h&r block If you sell the land for $12,000, you will have a $2,000 gain because you must use the donor's adjusted basis ($10,000) at the time of the gift as your basis to figure gain. Free tax h&r block If you sell the land for $7,000, you will have a $1,000 loss because you must use the FMV ($8,000) at the time of the gift as your basis to figure a loss. Free tax h&r block If the sales price is between $8,000 and $10,000, you have neither gain nor loss. Free tax h&r block For instance, if the sales price was $9,000 and you tried to figure a gain using the donor's adjusted basis ($10,000), you would get a $1,000 loss. Free tax h&r block If you then tried to figure a loss using the FMV ($8,000), you would get a $1,000 gain. Free tax h&r block Business property. Free tax h&r block   If you hold the gift as business property, your basis for figuring any depreciation, depletion, or amortization deduction is the same as the donor's adjusted basis plus or minus any required adjustments to basis while you hold the property. Free tax h&r block FMV Equal to or More 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. Free tax h&r block Increase your basis by all or part of any gift tax paid, depending on the date of the gift. Free tax h&r block Also, for figuring gain or loss from a sale or other disposition of the property, or for figuring depreciation, depletion, or amortization deductions on business property, you must increase or decrease your basis by any required adjustments to basis while you held the property. Free tax h&r block See Adjusted Basis earlier. Free tax h&r block Gift received before 1977. Free tax h&r block   If you received a gift before 1977, increase your basis in the gift (the donor's adjusted basis) by any gift tax paid on it. Free tax h&r block However, do not increase your basis above the FMV of the gift at the time it was given to you. Free tax h&r block Example 1. Free tax h&r block You were given a house in 1976 with an FMV of $21,000. Free tax h&r block The donor's adjusted basis was $20,000. Free tax h&r block The donor paid a gift tax of $500. Free tax h&r block Your basis is $20,500, the donor's adjusted basis plus the gift tax paid. Free tax h&r block Example 2. Free tax h&r block If, in Example 1, the gift tax paid had been $1,500, your basis would be $21,000. Free tax h&r block This is the donor's adjusted basis plus the gift tax paid, limited to the FMV of the house at the time you received the gift. Free tax h&r block Gift received after 1976. Free tax h&r block   If you received a gift after 1976, increase your basis in the gift (the donor's adjusted basis) by the part of the gift tax paid on it that is due to the net increase in value of the gift. Free tax h&r block Figure the increase by multiplying the gift tax paid by a fraction. Free tax h&r block The numerator of the fraction is the net increase in value of the gift and the denominator is the amount of the gift. Free tax h&r block   The net increase in value of the gift is the FMV of the gift less the donor's adjusted basis. Free tax h&r block 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. Free tax h&r block For information on the gift tax, see Publication 950, Introduction to Estate and Gift Taxes. Free tax h&r block Example. Free tax h&r block In 2010, you received a gift of property from your mother that had an FMV of $50,000. Free tax h&r block Her adjusted basis was $20,000. Free tax h&r block The amount of the gift for gift tax purposes was $37,000 ($50,000 minus the $13,000 annual exclusion). Free tax h&r block She paid a gift tax of $9,000. Free tax h&r block Your basis, $27,290, is 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 ÷ $37,000) . Free tax h&r block 81 Gift tax due to net increase in value $7,290 Adjusted basis of property to your mother 20,000 Your basis in the property $27,290 Inherited Property Special rules apply to property acquired from a decedent who died in 2010. Free tax h&r block See Publication 4895, Tax Treatment of Property Acquired From a Decedent Dying in 2010, for details. Free tax h&r block If you inherited property from a decedent who died before 2010, your basis in property you inherit from a decedent is generally one of the following. Free tax h&r block The FMV of the property at the date of the individual's death. Free tax h&r block The FMV on the alternate valuation date if the personal representative for the estate chooses to use alternate valuation. Free tax h&r block For information on the alternate valuation date, see the Instructions for Form 706. Free tax h&r block The value under the special-use valuation method for real property used in farming or a closely held business if chosen for estate tax purposes. Free tax h&r block This method is discussed later. Free tax h&r block 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. Free tax h&r block For information on a qualified conservation easement, see the Instructions for Form 706. Free tax h&r block 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. Free tax h&r block For more information, see the Instructions for Form 706. Free tax h&r block Appreciated property. Free tax h&r block   The above rule does not apply to appreciated property you receive from a decedent if you or your spouse originally gave the property to the decedent within 1 year before the decedent's death. Free tax h&r block Your basis in this property is the same as the decedent's adjusted basis in the property immediately before his or her death, rather than its FMV. Free tax h&r block Appreciated property is any property whose FMV on the day it was given to the decedent is more than its adjusted basis. Free tax h&r block 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. Free tax h&r block 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. Free tax h&r block For this rule to apply, at least half the value of the community property interest must be includable in the decedent's gross estate, whether or not the estate must file a return. Free tax h&r block For example, you and your spouse owned community property that had a basis of $80,000. Free tax h&r block When your spouse died, half the FMV of the community interest was includible in your spouse's estate. Free tax h&r block The FMV of the community interest was $100,000. Free tax h&r block The basis of your half of the property after the death of your spouse is $50,000 (half of the $100,000 FMV). Free tax h&r block The basis of the other half to your spouse's heirs is also $50,000. Free tax h&r block For more information on community property, see Publication 555, Community Property. Free tax h&r block Property Held by Surviving Tenant The following example explains the rule for the basis of property held by a surviving tenant in joint tenancy or tenancy by the entirety. Free tax h&r block Example. Free tax h&r block John and Jim owned, as joint tenants with right of survivorship, business property they purchased for $30,000. Free tax h&r block John furnished two-thirds of the purchase price and Jim furnished one-third. Free tax h&r block Depreciation deductions allowed before John's death were $12,000. Free tax h&r block Under local law, each had a half interest in the income from the property. Free tax h&r block At the date of John's death, the property had an FMV of $60,000, two-thirds of which is includable in John's estate. Free tax h&r block Jim figures his basis in the property at the date of John's death as follows: Interest Jim bought with his own funds—1/3 of $30,000 cost $10,000   Interest Jim received on John's death—2/3 of $60,000 FMV 40,000 $50,000 Minus: ½ of $12,000 depreciation before John's death 6,000 Jim's basis at the date of John's death $44,000 If Jim had not contributed any part of the purchase price, his basis at the date of John's death would be $54,000. Free tax h&r block This is figured by subtracting from the $60,000 FMV, the $6,000 depreciation allocated to Jim's half interest before the date of death. Free tax h&r block If under local law Jim had no interest in the income from the property and he contributed no part of the purchase price, his basis at John's death would be $60,000, the FMV of the property. Free tax h&r block Qualified Joint Interest Include one-half of the value of a qualified joint interest in the decedent's gross estate. Free tax h&r block It does not matter how much each spouse contributed to the purchase price. Free tax h&r block Also, it does not matter which spouse dies first. Free tax h&r block A qualified joint interest is any interest in property held by husband and wife as either of the following. Free tax h&r block Tenants by the entirety, or Joint tenants with right of survivorship if husband and wife are the only joint tenants. Free tax h&r block Basis. Free tax h&r block   As the surviving spouse, your basis in property you owned with your spouse as a qualified joint interest is the cost of your half of the property with certain adjustments. Free tax h&r block Decrease the cost by any deductions allowed to you for depreciation and depletion. Free tax h&r block Increase the reduced cost by your basis in the half you inherited. Free tax h&r block Farm or Closely Held Business Under certain conditions, when a person dies the executor or personal representative of that person's estate can choose to value the qualified real property on other than its FMV. Free tax h&r block If so, the executor or personal representative values the qualified real property based on its use as a farm or its use in a closely held business. Free tax h&r block If the executor or personal representative chooses this method of valuation for estate tax purposes, that value is the basis of the property for the heirs. Free tax h&r block Qualified heirs should be able to get the necessary value from the executor or personal representative of the estate. Free tax h&r block Special-use valuation. Free tax h&r block   If you are a qualified heir who received special-use valuation property, your basis in the property is the estate's or trust's basis in that property immediately before the distribution. Free tax h&r block Increase your basis by any gain recognized by the estate or trust because of post-death appreciation. Free tax h&r block Post-death appreciation is the property's FMV on the date of distribution minus the property's FMV either on the date of the individual's death or the alternate valuation date. Free tax h&r block Figure all FMVs without regard to the special-use valuation. Free tax h&r block   You can elect to increase your basis in special-use valuation property if it becomes subject to the additional estate tax. Free tax h&r block This tax is assessed if, within 10 years after the death of the decedent, you transfer the property to a person who is not a member of your family or the property stops being used as a farm or in a closely held business. Free tax h&r block   To increase your basis in the property, you must make an irrevocable election and pay interest on the additional estate tax figured from the date 9 months after the decedent's death until the date of the payment of the additional estate tax. Free tax h&r block If you meet these requirements, increase your basis in the property to its FMV on the date of the decedent's death or the alternate valuation date. Free tax h&r block The increase in your basis is considered to have occurred immediately before the event that results in the additional estate tax. Free tax h&r block   You make the election by filing with Form 706-A a statement that does all of the following. Free tax h&r block Contains your name, address, and taxpayer identification number and those of the estate; Identifies the election as an election under section 1016(c) of the Internal Revenue Code; Specifies the property for which the election is made; and Provides any additional information required by the Instructions for Form 706-A. Free tax h&r block   For more information, see the Instructions for Form 706 and the Instructions for Form 706-A. Free tax h&r block 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 must figure its basis for depreciation. Free tax h&r block An example of changing property held for personal use to business use would be renting out your former main home. Free tax h&r block Basis for depreciation. Free tax h&r block   The basis for depreciation is the lesser of the following amounts. Free tax h&r block The FMV of the property on the date of the change, or Your adjusted basis on the date of the change. Free tax h&r block Example. Free tax h&r block Several years ago you paid $160,000 to have your home built on a lot that cost $25,000. Free tax h&r block 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. Free tax h&r block Because land is not depreciable, you include only the cost of the house when figuring the basis for depreciation. Free tax h&r block Your adjusted basis in the house when you changed its use was $178,000 ($160,000 + $20,000 − $2,000). Free tax h&r block 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. Free tax h&r block The basis for figuring depreciation on the house is its FMV on the date of change ($165,000) because it is less than your adjusted basis ($178,000). Free tax h&r block Sale of property. Free tax h&r block   If you later sell or dispose of property changed to business or rental use, the basis of the property you use will depend on whether you are figuring gain or loss. Free tax h&r block Gain. Free tax h&r block   The basis for figuring a gain is your adjusted basis when you sell the property. Free tax h&r block Example. Free tax h&r block 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. Free tax h&r block Your adjusted basis for figuring gain is $165,500 ($178,000 + $25,000 (land) − $37,500). Free tax h&r block Loss. Free tax h&r block   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. Free tax h&r block Then adjust this amount for the period after the change in the property's use, as discussed earlier under Adjusted Basis, to arrive at a basis for loss. Free tax h&r block Example. Free tax h&r block 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. Free tax h&r block 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) on that date. Free tax h&r block Reduce that amount ($180,000) by the depreciation deductions to arrive at a basis for loss of $142,500 ($180,000 − $37,500). Free tax h&r block How To Get Tax Help You can get help with unresolved tax issues, order free publications and forms, ask tax questions, and get more information from the IRS in several ways. Free tax h&r block By selecting the method that is best for you, you will have quick and easy access to tax help. Free tax h&r block Contacting your Taxpayer Advocate. Free tax h&r block   The Taxpayer Advocate Service (TAS) is an independent organization within the IRS. Free tax h&r block We help taxpayers who are experiencing economic harm, such as not being able to provide necessities like housing, transportation, or food; taxpayers who are seeking help in resolving tax problems with the IRS; and those who believe that an IRS system or procedure is not working as it should. Free tax h&r block Here are seven things every taxpayer should know about TAS. Free tax h&r block TAS is your voice at the IRS. Free tax h&r block Our service is free, confidential, and tailored to meet your needs. Free tax h&r block You may be eligible for our help if you have tried to resolve your tax problem through normal IRS channels and have gotten nowhere, or you believe an IRS procedure just isn't working as it should. Free tax h&r block We help taxpayers whose problems are causing financial difficulty or significant cost, including the cost of professional representation. Free tax h&r block This includes businesses as well as individuals. Free tax h&r block Our employees know the IRS and how to navigate it. Free tax h&r block If you qualify for our help, we'll assign your case to an advocate who will listen to your problem, help you understand what needs to be done to resolve it, and stay with you every step of the way until your problem is resolved. Free tax h&r block We have at least one local taxpayer advocate in every state, the District of Columbia, and Puerto Rico. Free tax h&r block You can call your local advocate, whose number is in your phone book, in Publication 1546, Taxpayer Advocate Service—Your Voice at the IRS, and on our website at www. Free tax h&r block irs. Free tax h&r block gov/advocate. Free tax h&r block You can also call our toll-free line at 1-877-777-4778 or TTY/TDD 1-800-829-4059. Free tax h&r block You can learn about your rights and responsibilities as a taxpayer by visiting our online tax toolkit at www. Free tax h&r block taxtoolkit. Free tax h&r block irs. Free tax h&r block gov. Free tax h&r block You can get updates on hot tax topics by visiting our YouTube channel at www. Free tax h&r block youtube. Free tax h&r block com/tasnta and our Facebook page at www. Free tax h&r block facebook. Free tax h&r block com/YourVoiceAtIRS, or by following our tweets at www. Free tax h&r block twitter. Free tax h&r block com/YourVoiceAtIRS. Free tax h&r block Low Income Taxpayer Clinics (LITCs). Free tax h&r block   The Low Income Taxpayer Clinic program serves individuals who have a problem with the IRS and whose income is below a certain level. Free tax h&r block LITCs are independent from the IRS. Free tax h&r block Most LITCs can provide representation before the IRS or in court on audits, tax collection disputes, and other issues for free or a small fee. Free tax h&r block If an individual's native language is not English, some clinics can provide multilingual information about taxpayer rights and responsibilities. Free tax h&r block For more information, see Publication 4134, Low Income Taxpayer Clinic List. Free tax h&r block This publication is available at IRS. Free tax h&r block gov, by calling 1-800-TAX-FORM (1-800-829-3676), or at your local IRS office. Free tax h&r block Free tax services. Free tax h&r block   Publication 910, IRS Guide to Free Tax Services, is your guide to IRS services and resources. Free tax h&r block Learn about free tax information from the IRS, including publications, services, and education and assistance programs. Free tax h&r block The publication also has an index of over 100 TeleTax topics (recorded tax information) you can listen to on the telephone. Free tax h&r block The majority of the information and services listed in this publication are available to you free of charge. Free tax h&r block If there is a fee associated with a resource or service, it is listed in the publication. Free tax h&r block   Accessible versions of IRS published products are available on request in a variety of alternative formats for people with d