Understanding the original basis of a property and its tax implications
By Cora M. Barnhart • Bankrate.com

Oct. 14, 1999 -- Anyone who has ever considered buying or selling a share in a partnership probably knows that incoming partners go about paying for their share in a number of different ways. While some people pay cash, others obtain their share using property.

Newcomers may be shocked to discover that exchanging property for a share in a partnership complicates their tax situation. The partner's share in the business and its taxes depends on the basis of the property he contributes.

What is basis? In tax terms, it's a starting point -- the sum against which you determine depreciation or calculate gain or loss on the sale of property.

This tax tip shows partnerships what determines the original basis of a property. A related tax tip explains how circumstances that follow will determine the adjusted basis.

Acquisition method determines original basis
How the owner calculates the original basis depends on the way it was acquired.

Here are the four basic ways property is acquired, and how to calculate the basis.

1. The property is purchased or built, as in the case of a home.
If someone buys the property, the amount paid determines the basis. This includes most settlement or closing costs paid for the purchase and any debt assumed. If the owner built a structure on the property, the basis includes the settlement or closing costs of acquiring the lot and securing the mortgage.

2. The property is received as a gift.
If the property was a gift, the basis is usually whatever the donor's adjusted basis was at the time the recipient received it. However, if the recipient realizes a loss when he goes to sell this property, calculating the basis is more complicated. In situations where the fair market value on the date he received the gift is less than the donor's adjusted basis, the recipient's basis will be the fair market value.

3. The property is inherited.
With inherited property, the basis is the fair market value on the date of the deceased's death. This value is recorded on the federal estate and/or the state inheritance tax return filed for the deceased.

4. The property is secured from an ex-spouse because of divorce.
When property is received in this fashion, the basis is the same as the ex-spouse's just before the transfer took place.

Keeping records
A budding entrepreneur who wants to use property to obtain a share in a business had better keep accurate records. Taking the time to set up a filing system right away makes it possible to keep track of any factors that affect a property's basis. Someone who buys a home, for example, should save the settlement statement. Objective evidence of value is also important in situations where a property is acquired by gift, inheritance or divorce.

As a related tax tip explains, the property owner will need to continue maintaining these records. Hang on to receipts, canceled checks, and other records for all basis adjustments, especially improvements. Plan on keeping the records after exchanging the property for the partnership share. You never know when the IRS will have a question.

-- Posted Oct. 14, 1999