Basis in assets for purposes of determining gain and tax
What is "basis" in an asset? What does it mean?
"Basis" is defined by Black's Law Dictionary (6th ed.) as "The value assigned to an asset for the purpose of determining gain (or loss) on the sale or transfer or in determining value in the hands of a donee". Stated in layman's terms, your basis in an asset is the threshold for determining if any tax is due when the asset is subsequently sold.
How is basis determined? What is cost basis?
A person's basis in an asset is initially his "cost-basis" in a purchased asset, i.e., the amount that was paid for an asset. Assuming there has been no depreciation claimed on tax returns (which would reduce basis), nor any significant capital improvements to the asset (which would increase basis), a person's cost basis will remain as the basis until the asset is sold. (On the other hand, if the basis has been increased or decreased it is referred to as "Adjusted Basis".)
What is carryover basis?
If an asset is gifted during life to a third party, that person (the "donee") takes what is known as a "carryover basis", such that the donee's basis is the same as that of the donor, whether that is the cost basis or adjusted basis. This is generally the rule for any asset gifted during life.
What does "stepped up basis" mean?
If an asset is instead inherited by a person upon another's death, the recipient receives a "stepped up basis" such that the recipient's basis becomes the value of the asset on the date of the decedent's death. As such, capital gains taxes are only due upon a subsequent sale to the extent the sales price exceeds the stepped-up basis.
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