Tax basis: how to find it for any asset
Basis is the amount of investment a taxpayer has in property for tax purposes, and it decides how much gain or loss is recognized on a sale. The decision rule: ask first how the taxpayer got the asset (bought, gifted, inherited, received for services, exchanged, converted from personal use), apply the starting-basis rule for that route, then adjust for improvements, depreciation and other events. This guide uses tax year 2025 and the IRS sources Publication 551 (12/2025), Publication 550 (2025), Publication 541 (12/2025) and the Instructions for Form 7203. It is exam preparation, not tax advice.
The starting basis, by how the asset arrived
| How acquired | Starting basis | Source |
|---|---|---|
| Purchase | Cost: cash, debt, other property or services, plus items such as sales tax, freight, installation (stock: price plus commissions) | Pub 551 |
| Gift | Donor’s adjusted basis; if the fair market value (FMV) at the gift date is lower, the FMV is used to figure a loss. Gift tax attributable to net appreciation may be added | Pub 551 |
| Inheritance | Generally FMV at the date of death, or at the alternate valuation date if the executor elects it | Pub 551 |
| Services | The FMV included in income | Pub 551 |
| Taxable exchange | FMV of the property received | Pub 551 |
| Nontaxable exchange | Carryover of the basis of the property given up, adjusted for money, liabilities and recognized gain | Pub 551 |
| Transfer from a spouse (or former spouse, incident to divorce) | The spouse’s adjusted basis | Pub 551 |
| Personal use changed to business or rental | For depreciation, the lesser of FMV or adjusted basis on the date of the change | Pub 551 |
Adjusted basis moves from that start. Capital improvements are added; depreciation (taken or allowable), section 179 deductions, casualty and theft loss deductions and certain credits reduce it (Pub 551). Land is never depreciated, so a purchase of land and building needs an allocation of cost between them before depreciation starts, as depreciation and MACRS shows.
Worked examples
Gifted property: the dual basis. Marcus gets stock with a donor’s basis of $40,000 and an FMV of $30,000 on the gift date. If Marcus later sells for $50,000, the gain basis is $40,000 and the gain is $10,000. If he sells for $25,000, the loss basis is $30,000 and the loss is $5,000. A sale for $35,000, between the two figures, produces neither gain nor loss (Pub 551). When FMV at the gift date is equal to or more than the donor’s basis, the basis is simply the donor’s adjusted basis.
Inherited property. Nadia’s father paid $20,000 for shares worth $90,000 on the date of his death. Her basis is $90,000, not $20,000. A sale for $95,000 gives a $5,000 gain, and Pub 550 says gain or loss on inherited capital assets is long-term regardless of how long the heir held them. The tested trap is carryover basis applied to an inheritance.
Stock splits. Basis spreads over more shares. Pub 550 says nontaxable stock dividends and splits reduce the per-share basis of the original stock. For example, 100 shares that cost $3,000 and then split 3 for 1 become 300 shares at $10 each; the total basis stays $3,000. Only a taxable stock dividend gives the new shares a basis equal to their FMV on the distribution date, with the old stock unchanged.
Converted property. A taxpayer rents out a former home. The house (not the land) has an adjusted basis of $150,000 and an FMV of $130,000 on the conversion date. The basis for depreciation is $130,000, the lesser amount.
Basis in entities and accounts
These carry their own adjustment rules and are the Part 2 side of the topic.
Partner’s interest (Pub 541). The basis starts at money contributed plus the adjusted basis of contributed property. It increases with additional contributions (including a larger share of partnership liabilities) and the partner’s share of income, and decreases, never below zero, by distributions of money and property (including a decreased share of liabilities) and the share of losses. Example: a partner contributes $20,000 cash and equipment with an adjusted basis of $10,000 and FMV of $25,000, so starting basis is $30,000, not $45,000. Share of income $12,000 gives $42,000; a $5,000 cash distribution gives $37,000; a liability share increase of $8,000 gives $45,000. A loss share above $45,000 is not deductible beyond basis, because a partner’s loss is limited to the adjusted basis of the interest. Cash distributed above basis produces gain.
S corporation stock (Form 7203 instructions). Stock basis is adjusted each year in this order: increase for income items; decrease (not below zero) for distributions; decrease for nondeductible expenses; decrease for losses and deductions. Loss items beyond stock basis can use loan basis in debts the corporation owes the shareholder. Distributions do not reduce loan basis, and a loan the shareholder guarantees does not create basis until the shareholder pays on it.
Traditional IRA (Pub 590-A). Nondeductible contributions create cost basis, tracked on Form 8606; the basis is the nondeductible contributions minus withdrawals of them, and distributions are partly taxable and partly return of basis.
Which exams test this
| Exam | How the topic appears | Covered on this site |
|---|---|---|
| SEE Part 1 | Domain 2, Income and Assets (17 scored questions): basis of assets purchased, gifted or inherited; basis of stock after splits and stock dividends; basis in a traditional IRA (Form 8606); basis within Schedule K-1 pass-through items; depreciation recapture on sale | Income and assets covers purchased, gifted and inherited basis |
| SEE Part 2 | Domain 1, Business Entities (30): partner’s basis, basis on contribution of property and liabilities, and S corporation shareholder basis including loan basis. Domain 2, Business Tax Preparation (37): basis of business assets and converted property | Business entities covers partner and shareholder basis; business tax preparation lists asset basis |
How exam questions are built
- Which basis for which purpose. Gift questions set FMV below the donor’s basis and give a sale price in the gap, which is the neither-gain-nor-loss zone.
- Date-of-death value. Inheritance questions mention a low cost to the decedent to tempt carryover basis.
- Holding period. Inherited capital assets are always long-term, which matters for the netting in capital gains and losses.
- FMV is not basis. Partners and shareholders start from adjusted basis of what they contribute, not FMV.
- Order of S corporation adjustments, and liabilities moving partner basis in both directions.
- Never below zero. Excess distributions create gain, excess losses are not deductible.
Basis also appears when business income is reported on Schedule C for assets that are depreciated.
Practice questions
Question 1. Tara receives a gift of stock. The donor's adjusted basis was $18,000 and the fair market value on the gift date was $12,000. No gift tax was paid. Tara later sells the stock for $15,000. What is her recognized gain or loss?
- A. $3,000 loss
- B. $3,000 gain
- C. $15,000 gain
- D. Neither gain nor loss
Show answer
Answer: D
Because the FMV at the gift date is below the donor’s basis, the gain basis is $18,000 and the loss basis is $12,000. A sale at $15,000 is below $18,000, so there is no gain, and above $12,000, so there is no loss. Option A applies the donor’s basis to a loss and option B applies the FMV to a gain, which the dual-basis rule does not allow. Option C ignores basis altogether.
Question 2. Owen inherits a rental house from his aunt, who paid $60,000 for it and had depreciated it to an adjusted basis of $40,000. Its fair market value on the date of her death was $200,000. No alternate valuation date is elected. What is Owen's starting basis?
- A. $40,000
- B. $200,000
- C. $60,000
- D. $100,000
Show answer
Answer: B
Inherited property generally takes its fair market value at the date of death, here $200,000, so the aunt’s cost and depreciation no longer matter. Her cost ($60,000) and adjusted basis ($40,000) are carryover figures that apply to gifts, not inheritances. Option D adds her cost and her adjusted basis together, which no rule does.