I have a question on determining the tax basis on a farm. Imagine a family that has owned a piece of farmland since the 1800’s. In such a situation, how do you figure out the tax basis of that property for tax liability?
This is an excellent question that can have a complex answer. To find the answer, here are some questions you should ask:
How long has the person had the property and how did you get the property?
Did they purchase the property and have a “cost basis" for what they paid for it (together with expenditures they may have for capital improvements)?
Were they gifted the property and received it with “carry-over basis” from the grantor of the gift? (26 U.S.C. §1015(a) - providing for carryover basis of gifts) Taft v. Bowers, 278 U.S. 470 (1929)
Did they inherit the property and receive a “step-up in basis” set at the fair market value of the decedent’s death? (26 U.S.C. §1014 providing for step-up the FMV)
Treasury Regulation Section 1.1001-1(a) Computation of gain or loss
General rule. Except as otherwise provided in subtitle A of the Code, the gain or loss realized from the conversion of property into cash, or from the exchange of property for other property differing materially either in kind or in extent, is treated as income or as loss sustained. The amount realized from a sale or other disposition of property is the sum of any money received plus the fair market value of any property (other than money) received. The fair market value of property is a question of fact, but only in rare and extraordinary cases will property be considered to have no fair market value. The general method of computing such gain or loss is prescribed by section 1001 (a) through (d) which contemplates that from the amount realized upon the sale or exchange there shall be withdrawn a sum sufficient to restore the adjusted basis prescribed by section 1011 and the regulations thereunder (i.e., the cost or other basis adjusted for receipts, expenditures, losses, allowances, and other items chargeable against and applicable to such cost or other basis). The amount which remains after the adjusted basis has been restored to the taxpayer constitutes the realized gain. If the amount realized upon the sale or exchange is insufficient to restore to the taxpayer the adjusted basis of the property, a loss is sustained to the extent of the difference between such adjusted basis and the amount realized. The basis may be different depending upon whether gain or loss is being computed. For example, see section 1015(a) and the regulations thereunder. Section 1001(e) and paragraph (f) of this section prescribe the method of computing gain or loss upon the sale or other disposition of a term interest in property the adjusted basis (or a portion) of which is determined pursuant, or by reference, to section 1014 (relating to the basis of property acquired from a decedent) or section 1015 (relating to the basis of property acquired by gift or by a transfer in trust).
Treasury Regulation Section 1.1011-1 Adjusted basis.
The adjusted basis for determining the gain or loss from the sale or other disposition of property is the cost or other basis prescribed in section 1012 or other applicable provisions of subtitle A of the code, adjusted to the extent provided in sections 1016, 1017, and 1018 or as otherwise specifically provided for under applicable provisions of internal revenue laws.
Treasury Regulation Section 1.1014-1 Basis of property acquired from a decedent.
General rule. ….The purpose of section 1014 is, in general, to provide a basis for property acquired from a decedent that is equal to the value placed upon such property for purposes of the federal estate tax. Accordingly, the general rule is that the basis of property acquired from a decedent is the fair market value of such property at the date of the decedent's death….
Treasury Regulation Section 1.1015-1 Basis of property acquired by gift after December 31, 1920.
(a) General rule. ….In the case of property acquired by gift after December 31, 1920 (whether by a transfer in trust or otherwise), the basis of the property for the purpose of determining gain is the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift….
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