Your basis in a business asset is the cost of that asset. The term applies to all kinds of major long-term assets owned by your business, including real estate (land and buildings), vehicles, and equipment. Asset basis affects depreciation expenses and capital gains taxes.
This article explains what to include on an original cost basis and how it is adjusted over its life and reported on your business tax return.
- The basis of an asset is its total cost, including costs for installation, training, and shipping.
- Asset basis may be adjusted for improvements, but not minor repairs.
- Asset basis is used in the calculation of depreciation, including depreciation expense for each year.
- Capital gains taxes at the sale of an asset are calculated using asset basis.
- The basis of all capital assets in a business is a measure of its value.
Understanding Asset Basis
The cost of an asset is used to establish the basis of capital assets in a business. Capital assets are major assets that generate value for a business over a long period of time. These assets include vehicles, buildings, machinery, equipment, and furniture. The term "capitalizing" is used to describe the process of buying an asset, determining its basis, and depreciating it instead of writing it off as an expense.
Asset cost is used for accounting purposes to show the value of assets on the business balance sheet. It's used for tax purposes to establish costs for purposes of determining depreciation during the asset's useful life and to calculate capital gains tax when it's sold.
Investments also have a cost basis, which includes broker's fees or commissions.
An asset's cost can include:
- Purchase price
- Sales tax
- Excise tax
- Settlement costs
- Import duties
- Freight and handling
- Interest costs
- Installation, assembly, and testing
- Real estate taxes (if assumed for the seller)
Asset basis also includes legal and accounting fees in some instances and the cost of major updates and replacements. For example, a warehouse may need a new roof or computer equipment may need new software.
What's Not Included in Asset Basis
Asset costs for determining the basis for business assets don't include:
- Administration and overhead costs
- Costs for maintenance and repair
- Minor replacement parts
- Consumables (like cleaning supplies or filters)
You may be able to write off these costs as expenses for the tax year.
For example, if you buy a computer system for your business, the basis can include delivery charges, sales taxes, and setup fees. It doesn't include the cost of printer paper or repairing a broken keypad key.
Basis for Different Kinds of Assets
The basis for intangible assets like patents, copyrights, and trademarks is usually the cost to buy or create the asset. Intangible assets are usually amortized, a process similar to depreciation.
Real estate, also called real property, is land and the buildings on the land. If you paid the real estate taxes for the seller, you can include those in basis. The cost of land generally includes the cost of clearing, grading, planting, and landscaping.
If you have a home and change it into a business property or property for rental, you can begin to depreciate it. The basis for this purpose is the lesser of
- The fair market value on the date of the change
- The adjusted basis on the date of the change
How Asset Basis Changes
The basis of an individual asset increases and decreases during the time you have the asset, and the basis affects the sale of the asset.
During the useful life of the asset, any improvements you make increase the basis. For example, if you put a new roof on a business building, the asset basis in that building is increased by the cost of the new roof. Other increases to basis include:
- Capital improvements like a new roof for your business building
- Assessments for local improvements, including water connections sidewalks, or roads
- Restoring damaged property after a casualty loss
- Zoning costs
- Legal fees for title work
The basis in an asset can decrease for
- Casualty or theft loss deductions and insurance reimbursements
- Certain vehicle credits
- Section 179 deductions
- Depreciation expenses taken
When you sell a business asset you must adjust the basis of the asset to know if there has been a gain or loss in value for capital gains tax purposes.
Why Asset Basis Is Important
Knowing the basis of an asset and including all aspects of the purchase of that asset is important because the basis is calculated differently for different purposes.
Asset basis is used to calculate the depreciation of an individual asset. A higher basis results in greater depreciation expense in each year of the asset's useful life.
Capital gains taxes are based on the gain in the price of the asset from the original cost of purchase or the basis. A higher basis can mean lower capital gains tax when the asset is sold.
If you have established the basis of an asset through valuation and records and you have a loss due to a business disaster, you can use that basis both for a casualty loss deduction on your business tax return and for insurance purposes. The loss might be calculated differently for each purpose.
The total basis for all capital assets in your business represents a big part of the value of your business. This value can be used in financial analysis, like the debt-to-asset ratio. A higher asset value shows a lower debt-to-asset ratio, meaning the company isn't at risk of insolvency or bankruptcy.