Taxation is a domain that is not just limited to a set of rules and regulations. There are many underlying concepts involved in the process of calculation of taxable income and tax liability. For the taxpayers in the US, numerous concepts make up the tax calculation structure. Tracking the basis for your entity is one of the many salient concepts.
If you have an S-corporation, C-corporation, or a partnership firm, understanding the tax concept of basis is cardinal for you. The process of estimating the basis for your entity plays a prime role in evaluating business investments and personal assets. Laymen can find the concept of basis a bit intricate to apprehend. It is best to engage experienced professionals such as CPAs to handle such tax demands.
As a deft taxation outsourcing company for firms in the US, our team from Initor Global, is here to throw light on the concept of basis and its bearing on calculating your entity’s tax liabilities.
Introduction to basis
As per the definition of the IRS, the basis is the amount of capital investment in an entity’s property for tax purposes. It acts as a key element in calculating depreciation, depletion, amortization, or casualty losses of your business property. The basis is also used to estimate your assets’ gain or loss on the sale, disposal, or exchange.
It is crucial to gauge the adjusted basis of your assets. You must go for the computation of the gain or loss from any asset’s sale or disposition using the adjusted basis. The same rule applies for reckoning the allowable depreciation for tax purposes.
Generally, the basis is nothing but the cost of the acquisition of an asset of your entity. Cost consists of the sum paid to acquire an asset and includes the cash price, loan obligations, and other additional property or service charges. The value of basis can rise or fall depending on your business activities in a given period. Hence, it would help if you calculated an adjusted basis.
Entities such as S-corporation must calculate the basis for each stakeholder annually. A track of the basis must be ensured since the inception of the ownership of the property.
Types of Basis
There are broadly two types of basis used for tax requirements- the stock basis and the debt basis.
The stock basis is mostly used to calculate depreciation and gain or loss on the assets of the basis.
The debt basis is used to calculate the value of loan repayments made by an entity. These loans comprise of direct loans from any shareholder to the relevant corporation.
Process of calculation of basis for your business property
The estimated basis for your property is subjective upon the initial method of acquiring the business property. Here, we shall find out the basic rule for calculation of basis based on how the business acquired the given property.
In this case, the amount that the entity pays to purchase the investment or property becomes the initial basis. The value also comprises of any expenses or commissions incurred in the process of making the purchase.
When you receive any business property as a gift, the estimation of basis relies on the outcome (loss or gain) of the ultimate sale or disposal of the asset. If you make a profitable sale of the property, the basis of the asset will be equivalent to the basis of the previous owner. Hence, the basis gets transferred along with the gifted property from the previous owner.
While, if one incurs a loss on the sale of the property, the adjusted basis shall be the value that is lower of the amount of basis for the previous owner or the property’s stock value at the time of the gift. All and all, your entity cannot write-off the loss that occurred while the donor owned the property.
In the scenario where an entity inherits stock or other property, the basis is the property’s valuation on the date of death of the previous owner. As per the tax regulations, no tax applies to the present owner on the gain in the value that existed when the previous owner was alive. Hence, the basis is stepped up to the current market value to account for the previous owner’s appreciation in value.
While, in the presence of any loss in the stock value during the term of ownership by the benefactor, the value is stepped down on the date of death. The increase or decrease in the asset’s value only after you inherit it is considered for tax purposes.
An exception called the alternate valuation date might apply to some large estates for which federal estate tax return has to be filed. This exception allows setting up the date of valuation 6 after the benefactor’s death or the sale value if sold during the 6 months.
Hence, if the estate executor wants to opt for an alternate valuation date, the inherited stock basis will be the value on such an alternate date.
The value is as per the principles of stock basis. The value incepts with the shareholders’ capital contributions to the corporation or the stock’s starting cost. The amount rises or falls depending on the pass-through amounts from the Partnership or S-corporations. Any gain or income element will cause a surge in the basis value, while any loss, distribution, or deduction will lower the basis value. As per the shareholders’ or partners’ investments in the S-corporation or partnership, the basis will vary. While in a C-corporation, the stock basis remains unchanged. However, the stock basis cannot be negative.
Importance of tracking basis for tax entities
It is essential to ensure precision while tracking your basis. The higher the amount of basis, the lesser will be the taxable gain for your entity.
The relevance of basis for S-corporations, C-corporations, and Partnerships’
Basis comes into the picture for tax calculations when:
Case-1 The company has losses
It helps to determine the deductible losses and the losses which can be suspended to the next years.
Case-2 The company makes distributions
It helps to assess whether the capital gains or losses are duly recognized. It also helps to find the maximum threshold for the distribution amount. It is because of the rule that the stock basis can never be negative.
Case-3 There is a change in the ownership
It helps to conclude the gain or loss incurred on exchange or sale of partnership interest or corporation share.
The relevance of basis for rental properties and assets for personal use
The basis will help find the amount of gain or loss recognizable on the sale or exchange of rented or personal property. The adjusted basis refers to the sum of the purchase price, the cost of capital improvements and costs of sale, reduced by tax deductions such as depreciation claimed previously.
Adverse consequences of not tracking basis
Ignoring the due calculations for the basis of the entity can lead to untoward consequences. It is highly recommended that CPA firms and business entities remain particular about the basis calculation since initiation. You can face the following issues if you do not accurately track the basis.
Steps to follow if tax entities do not track their basis
The entities that are not keeping a track on their basis can refer to the following steps:
Case-1: For Shareholders of S-corporations, C-corporations, and Partnerships
Entities that are not tracking the basis since their commencement need to reconstruct their basis. You need to track down all Capital records and K-1 Schedules for different years since the stock acquisition. Once all documents are obtained, reconstruction involves the accumulation of yearly increases or decreases from the acquisition date to the current year.
Case-2: For property excluding investments in S-corporations, C-corporations, and Partnerships
You need to use original records such as property papers to track the basis. Consult the broker or realtor to get the proper valuation details.
Never miss any relevant IRS notification or tax amendment! Collaborate with Initor Global!
Remain on top of all tax updates with the agile team of tax maestros at Initor Global. Hire our tax preparation outsourcing services to manage the myriad tax affairs of your business, such as the basis tracking. Contact Initor Global today!