Income Tax Basis: Overview and Conceptual Aspects (Portfolio 560)

Tax Management Portfolio No. 560-3rd, Income Tax Basis: Overview and Conceptual Aspects, analyzes in depth the definition, nature, concept, scope, use, and computation of income tax basis and its variants. The discussion includes a historical summary of the development of the principal income tax basis provisions, and an examination of the purposes for which basis is significant in analyzing or determining tax consequences.

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Tax Management Portfolio No. 560-3rd, Income Tax Basis: Overview and Conceptual Aspects, analyzes in depth the definition, nature, concept, scope, use, and computation of income tax basis and its variants. The discussion includes a historical summary of the development of the principal income tax basis provisions, and an examination of the purposes for which basis is significant in analyzing or determining tax consequences. Each provision affecting basis or a variant of basis is described. For provisions that are the subject of other Portfolios, the description provides an overview and an introduction to the terminology and substantive rules. For the other basis provisions, the principles are analyzed in depth.
The analysis of the basis provisions is divided into six major topics, beginning with the significance of basis and proceeding through the computation of basis, the computation of adjusted basis, allocation of basis, timing issues affecting basis, and recordkeeping and reporting with respect to basis. The computation of basis and computation of adjusted basis topics are organized categorically. The discussion of basis includes acquisition basis, acquisition costs, and the impact of liabilities. In the material on computing adjusted basis, more than a dozen groups of basis adjustments are discussed. The discussion of acquisition basis includes extensive analysis of cost basis, basis in property acquired through exchanges, basis in gifts, basis in property received through a decedent, basis in distributed property, and basis in property acquired through contribution.


James Edward Maule

James Edward Maule, B.S., University of Pennsylvania (1973); J.D., Villanova University (1976); LL.M. (Taxation), George Washington University (1979); lecturer, Villanova University Graduate Tax Program and Tax Forum CLE Programs; lecturer, Philadelphia Bar Association Tax Section; member, U.S. Income Advisory Board, Tax Management, Inc.; former attorney-advisor, United States Tax Court, Judge Herbert L. Chabot; former attorney-advisor, Chief Counsel to the Internal Revenue Service; former Editorial Advisory Board member and columnist, Journal of Limited Liability Companies; former lecturer, ALI-ABA; former lecturer, Tax Management, Inc. & Continuing Legal Education Satellite Network; former lecturer, Pennsylvania Bar Institute; former lecturer, Georgetown University Law Center Institute on State and Local Taxation; former lecturer, The Dickinson School of Law CLE Programs; member, American Bar Association, Section of Taxation, Committee on S Corporations (Consultant and former Chair, Subcommittee on Subchapter S and State Law; former Chair, Subcommittee on Comparison of Partnerships and S Corporations); member, American Bar Association, Section of Taxation, Committee on Teaching Taxation (Chair, Subcommittee on Manuscripts and Unpublished Teaching Materials; member, Subcommittee on Important Developments); member, American Bar Association, Section of Taxation, Tax Practice Management Committee; member, American Bar Association, Section of Taxation, Formation of Tax Policy Committee; member, American Bar Association, Section of Taxation, Committee on Tax Structure and Simplification; former Chair, American Bar Association, Section of Taxation, Phaseout Tax Elimination Project; former member, American Bar Association, Section of Taxation, Task Force on Pass-Through Entities; former member, American Bar Association, Section of Taxation, Task Force on Legislative Recommendation No. 86-1; former member, Philadelphia Bar Association Tax Section; author and owner, TaxJEM Inc., publisher of computer assisted legal instruction programs; owner, JEMBook Publishing Company, publisher of law and genealogy books; author of numerous books, monographs, and book chapters; contributor to various tax periodicals.

Table of Contents

Detailed Analysis

I. Introduction

A. The Concept of Basis

1. In General

2. Basis Variations

a. Introduction

b. Adjusted Basis

c. Unadjusted Basis

d. Depreciable Basis

e. Amortizable Basis

f. Depletion Basis

g. Original Basis

h. Acquisition Basis

i. Cost Basis

j. Valuation Basis

k. Substituted Basis

l. Transferred Basis

m. Exchanged Basis

n. Carryover Basis

o. Stepped-Up Basis

p. Uniform Basis and Uniform Adjusted Basis

q. Recomputed Basis

r. Eligible Basis

s. Qualified Basis

t. Loss Basis

u. Gain Basis

v. Inside Basis

w. Outside Basis

3. Concepts Similar To Basis

a. Amount at Risk

b. Partner Capital Account

c. Partnership Cash Basis

4. Basis for Special Purposes

a. Basis for Earnings and Profits Purposes

b. Basis for AMT Purposes

(1) Introduction

(2) Depreciable Property

(3) Pollution Control Property

(4) Mining Property Costs

(5) Circulation Expenditures

(6) Research and Experimental Expenditures

(7) Incentive Stock Option Basis

(8) Merchant Marine Capital Construction Funds

(9) Adjusted Current Earnings

5. Other Usages of the Term “Basis”

a. Method of Accounting Basis

b. Annual and Annualized Basis

c. Discount Basis

d. Grounds

6. Negative Basis

a. In General

b. Consolidated Returns

7. The Impact on Basis of Incorrect Reporting

a. Introduction

b. Prerequisites for Mitigation

c. Circumstances for Basis Mitigation

d. Mitigation Adjustment

8. Basis Provisions No Longer in Code

B. A Brief History of Basis

1. The Early Years

2. The Internal Revenue Code of 1954

3. The Internal Revenue Code of 1986

C. Overview of the Portfolio

II. The Significance of Basis

A. In General

B. Computation of Gain and Loss

C. Computation of Deductions

D. Computation of Credits

E. Computation of Limitations

F. Computation of Credit Recapture

G. Defining Terms, Conditions, Qualifications, and Similar Status

H. Computation of Earnings and Profits

I. Determining Carryover of Tax Attributes

J. Tacking Holding Periods

K. As Substitute for Some Other Amount

III. The Computation of Basis

A. In General

B. Acquisition Basis

1. Cost Basis

a. Purchase

(1) In General

(2) Determination of Cost

(3) Cost Reductions

(4) Reacquisition from Creditors

(5) Use of Annuity Transactions

(6) Use of An Option

(a) In General

(b) Stock Acquired Under Qualified Stock Option

(c) Basis Attributable to Exercise of Certain Sale Options

b. Constructed Property

(1) In General

(2) Produced Property Basis Rules

(a) In General

(b) Allocable Costs

(i) In General

(ii) Qualified Interest Costs

(c) Produced Property

(i) In General

(ii) Self-Produced Property

(iii) Property Acquired for Resale

(d) Exceptions

(i) Research and Experimental Expenditures

(ii) Deductible Oil, Gas, and Mineral Costs

(iii) Timber and Ornamental Trees

(iv) Farming Business Qualified Products

(A) In General

(B) Preproductive Period

(C) Farming Business

(v) Plants Lost by Casualty

(A) In General

(B) Minority Owners

(vi) Plants Produced in Farming Business

(A) In General

(B) Limitation on Scope of Exception

(vii) Qualified Expenses of Qualified Creators

(A) In General

(B) Qualified Creator

(C) Qualified Corporations

(viii) Cushion Gas

(ix) Construction in Progress

(3) Future Outlays

(a) In General

(b) Future Demolition, Removal, Reclamation, and Dismantling Costs

(c) Future Development Costs

(4) Basis for New Vessel Construction

c. Property Included in Inventory

d. Other Acquisitions

(1) In General

(2) Excludible Restitution Payments

e. Special Cost Basis Rules

(1) Redeemable Ground Rents

(2) Assets Acquired in Deemed Corporate Purchase

(a) In General

(b) Purchased Stock

(c) Grossed-Up Basis

(d) Alternative Basis in Nonrecently Purchased Stock

(3) Player Contracts

(4) Property Imported from Related Person

(a) In General

(b) Imported Property

(c) Customs Value

(i) In General

(ii) Adjustments to Customs Value

(iii) Property with Dutiable and Nondutiable Portions

(iv) Use of Averaged Customs Value

(d) Alternative Limitation Method

(e) Relationship to § 482

(f) Finality Customs Service Determinations

(5) Certain Foreign Intangible Drilling Costs

(6) Mines and Mineral Deposits

(7) Foreign Exploration Expenditures

2. Property Acquired in an Exchange

a. Taxable Exchanges

(1) In General

(2) Exchanges of Corporate Stock

(3) Debt Release

(4) Nondebt Claim

(5) Post-2009 Pecuniary Bequest Exchange

b. Nontaxable and Partially Taxable Exchanges

(1) In General: Substituted Basis

(2) Like-Kind Exchanges

(a) Section 1031 Like-Kind Exchanges

(b) Sections 1035, 1036, and 1037 Like-Kind Exchanges

(3) Involuntary Conversions

(a) In General

(b) Property Received as Foreign Expropriation Loss Recovery

(c) Property Acquired in SEC-Mandated Exchange

(i) In General

(ii) Stock or Securities

(iii) Property Acquired by Corporation for Property

(iv) Property Transferred to Corporation

(v) Distributed Stock or Securities

(vi) Exchanges Within System Group

(4) Replacement Principal Residence

(5) Reacquired Real Property Securing Buyer Indebtedness

(6) Stock and Securities Acquired in Wash Sale Transaction

(7) Securities Acquired Under Qualified Exchange Agreements

c. Installment Obligation Basis

3. Transferee Basis

a. Property Acquired by Gift

(1) In General

(2) Determining Donor's Basis

(3) Transfers in Trust After December 31, 1920

(4) Gifts and Trust Transfers Before January 1, 1921

(5) Increase for Gift Tax Paid

(a) In General

(b) Limitation

(c) Gift Tax Paid With Respect to Gift

(6) Part Gift, Part Sale

b. Property Acquired in Marital Transactions

c. Property Acquired From or Through a Decedent

(1) In General

(2) Fair Market Value

(3) Exceptions

(a) Alternate Valuation Date Exception

(b) Qualified Real Property Valuation Exception

(c) Qualified Conservation Easement Exception

(d) Property Disposed of Before Decedent's Death

(e) Transfers Within One Year of Death

(f) Income in Respect of a Decedent

(g) Reduced Basis

(h) DISC Stock

(i) Foreign Personal Holding Company Stock

(j) Passive Foreign Investment Company Stock

(k) Certain Community Property

(l) Decedents Dying Before March 1, 1913

(4) Property Passing From or Through a Decedent

(5) Decedents Dying After December 31, 2009

(a) In General

(b) General Basis Increase

(c) Spousal Basis Increase

(d) Qualified Property

(e) Large Death Transfer Information Return

d. Property Acquired Through Contribution

(1) Property Contributed to Corporation

(a) In General

(b) Contributions by Those Not Shareholders

(c) Contributions in Aid of Construction for Public Utilities

(d) Property Acquired by Consolidated or Affiliated Corporations

(i) Consolidated Corporation Transactions

(ii) Affiliated Corporation Transactions

(2) Property Contributed to Partnership

(3) Property Contributed to REMIC

(4) Property Acquired by Regulated Investment Company

(5) Property Acquired by Bankruptcy Estate

(6) Property Contributed to Political Organization

(7) Property Paid to Designated Settlement Fund

4. Property Acquired Through Distribution

a. Corporate Distributions

(1) Property

(a) In General

(b) Property Distributions by DISCs

(2) Stock and Stock Rights

(3) Complete Liquidations

(a) In General

(b) U.S. Real Property Interests

(4) Corporate Nonrecognition Transactions

(5) Property Distributed to Tax-Exempt Organization

b. Partnership Distributions

(1) Nonliquidating Distributions

(2) Liquidating Distributions

(3) Marketable Securities

(4) Special Rule for Corporate Partners

c. Property Distributions by Trusts and Estates

d. Property Distributions by REMICs

e. Stock Distribution by Common Trust Fund

f. Nonqualified Written Notices of Allocation and Retain Certificates

5. Property Acquired in Exchange for Contribution

a. Corporate Stock

(1) In General

(2) FNMA Stock

(3) Basis in Qualified Small Business Stock

(a) In General

(b) Qualified Small Business Stock

(c) Qualified Small Business

(d) Active Business Requirements

(i) In General

(ii) Special Rules

(A) Preliminary Activities

(B) Subsidiaries

(C) Working Capital

(D) Computer Software Royalties

(E) Specialized Small Business Investment Companies

(iii) Qualified Trade or Business

(iv) Eligible Corporation

b. Partnership Interest

c. REMIC Interest

C. Acquisition Costs

1. In General

2. Obligations of the Seller

3. Demolition of Acquired Building

4. Special Rules

a. Specified Policy Acquisition Expenses

(1) In General

(2) Deduction Maximum

(3) Basis Reduction for Negative Net Premiums

b. REMIC Organizational Expenses

D. Liabilities

1. In General

2. OID Limitation

a. In General

b. Basis Arising from Issuance of § 1274 Instruments

(1) In General

(2) Section 1274 Debt Instruments

c. Basis Arising from Issuance of Publicly Traded Debt Instrument

d. Basis Arising from Issuance of Other Debt Instruments

3. Fair Market Value Limit

4. Genuineness of Liability

5. Contingent Liabilities

6. Redeemable Ground Rents

E. Special Basis Rules

1. Basis Reflecting Prior Law

2. Property Acquired Before Effective Date of Income Tax

a. In General

b. Basis Adjustments for Periods Before March 1, 1913

c. Multiple Properties

d. Unproven Amounts

e. Fair Market Value

f. Determining Date of Acquisition

3. Basis for Income Forecast Method of Depreciation

4. Private Foundation Basis

a. Investment Income Excise Tax

b. Income Distribution Failure Excise Tax

5. Branch Profits Tax Basis

6. Basis For Taxing Permanent Residents Who Change Residence

7. Basis for Tax-Exempt Entities That Become Taxable

IV. The Computation of Adjusted Basis

A. In General

B. Adjustments to Basis

1. Increases for Expenditures

a. Capital Expenditures and Similar Items

(1) In General

(2) Expenses and Taxes Related to Ownership

(3) Identifying Affected Property

b. Deferred Research and Experimental Expenditures

c. Unamortized Soil and Water Conservation Expenditures

d. Mine Development and Exploration Expenditures

e. Discount Accrual on Debt Held by Life Insurance Company

2. Increases for Included Income and Recognized Gain

a. In General

b. Depreciation Recapture

c. Foreign Loss Recapture

d. Gain from Distributions to Property-Contributing Partner

e. Gain from Contributed Property Partnership Distribution

f. Gain Recognized by RIC Shareholder

g. Gain Recognized by RIC

h. Gain Recognized by Holder in a FASIT

i. Gain Recognized by Qualified Electing Fund Shareholder

j. Gain from Transfer of Passive Foreign Investment Company Stock

k. Consent Dividends

l. Gain from Foreign Corporation Transactions

m. Compensation from Exercise of Employee Stock Option

n. Gain on Reacquisition of Real Property

o. Debt Instrument OID

p. Market Discount on Bonds

q. Acquisition Discount on Short-Term Obligations

r. Accrued Interest and Market Discount on Stripped Bonds

s. Discount on Stripped Preferred Stock

t. Gain on Disposition of Market Discount Bond

u. S Corporation Inventory LIFO Recapture

v. Commodity Credit Corporation Loans

w. Gain from Disposition of Mining Property

3. Increases for Tax Paid

a. Additional Estate Tax for Specially Valued Property

b. Gift Tax Paid with Respect to Gift

c. Generation-Skipping Tax Paid on Generation-Skipping Transfers

d. Recapture of Qualified Electric Vehicle Credit for Vehicles Placed in Service Before 2007

e. Investment Credit Recapture

4. Increases for Disallowed Deductions

a. Real Property Reacquired by Seller's Estate

b. Payments in Lieu of Dividends on Stock Used in Short Sale

c. Unharvested Crop Sales

d. Coal and Iron Ore Disposals

e. Disallowed Cooperative Housing Corporation Payments

f. Nonrecognized Loss on Partial Disposition of Intangibles

g. Gifts of Activities with Passive Loss Carryovers

h. Dispositions of Activities with Unused Passive Credits

i. Passive Activities Distributed by Estate or Trust

j. Interest on Disqualified Debt Instruments

5. Reductions for Excluded or Deferred Income or Gain

a. Deferred Principal Residence Gain

b. Excluded Discharge of Indebtedness Income

(1) In General

(2) Depreciable Property Basis Reduction

(3) Qualified Real Property Business Indebtedness Discharge

(4) Qualified Farm Indebtedness Discharge

(5) Application of Reduction

(6) Special Rules

c. Nontaxed Portion of Extraordinary Dividend

d. Personal Injury Liability Qualified Funding Assets

e. Qualified Retirement Plan Net Unrealized Appreciation

f. ESOP Qualified Replacement Property

g. Conflict-of-Interest Permitted Replacement Property

h. Specialized Small Business Investment Company Interests

i. Qualified Small Business Stock Rollover

j. Qualified Empowerment Zone Assets

k. Excluded Energy Conservation Subsidies

l. Qualified Withdrawals from Merchant Marine Capital Construction Fund Accounts

m. Deferred Gain on the Disposition of Qualifying Vessels

n. Tax-Exempt Organizations Purchasing S Corporation Stock

6. Reductions for Allowable Deductions

a. Depreciation, Depletion, and Amortization

(1) In General

(2) Determination of Depreciation and Similar Deductions

(a) In General

(b) No Depreciation Claimed for ACRS Property

(c) No Depreciation Claimed for Other Property

(d) Depreciation on Qualifying Vessels

(3) Deductions for Years Before 1952

(4) Depletion

(5) Depreciation Causing Reduction of Tax Liability

(a) In General

(b) Multiple Properties

(c) Partners and Trust Beneficiaries

(d) Proof of Amount Allowed that Reduced Tax Liabilities

b. Depreciation for Periods Taxpayer Not Subject to Tax

c. Amortizable Bond Premium

d. Mine Development and Exploration Expenditures

e. Deferred Research and Experimental Expenditures

f. Premium Amortization on Debt Held by Life Insurance Company

g. Optional Ten-Year Tax Preference Write-Offs

h. Elimination of Double Deductions

i. Clean-Fuel Vehicles and Refueling Property

j. Sulfur Regulation Compliance Capital Cost Deduction

k. Energy Efficient Commercial Buildings Deduction

7. Reductions for Credits and Credit Equivalents

a. Qualified Electric Vehicle Credit for Vehicles Placed in Service Before 2007

b. Enhanced Oil Recovery Credit

c. Disabled Access Expenditure Credit

d. Investment Credits

e. Qualified Clinical Testing Expenditure Credit

f. Research Activity Expenditures

g. Adoption Expenses

h. Qualified Diesel-Powered Highway Vehicle Fuel Tax Repayment

i. Gas Guzzler Tax

j. First-Time District of Columbia Homebuyer Credit

k. New Markets Tax Credit

l. Employer-Provided Child Care Credit

m. Railroad Track Maintenance Credit

n. Residential Energy Efficient Property

o. Qualified Fuel Cells and Stationary Microturbine Power Plant Credit

p. Nonbusiness Energy Property Credit

q. New Energy Efficient Homes Credit

r. Alternative Motor Vehicle Credit

s. Alternative Fuel Vehicle Refueling Property Credit

t. Plug-in Electric Vehicle Credit

u. Qualified Plug-In Electric Drive Low-Speed Vehicle, Motorcycle, and Three-Wheeled Vehicle Credit

8. Reductions for Disallowed Deductions

a. Amortizable Bond Premium

b. Dealers’ Municipal Bonds

9. Reductions for Distributions

a. Corporate Distributions

b. S Corporation Distributions

c. Partnership Distributions

10. Reductions for Liability Relief

a. Commodity Credit Corporation Loans

b. Partnership Liabilities

11. Reductions for Specific Purposes

a. Loss Computation by Liquidating Corporation

b. Research and Experimental Expenditures of CFC

c. License Expenditures of CFC

12. Miscellaneous Basis Adjustments

a. Intragroup Stock Acquisitions

b. Intragroup Stock Dispositions

c. Interest Expense Allocation and Apportionment

d. Insurance Company Variable Contracts

C. Adjustments Precluded

1. Lessee Improvements

2. Depreciation for Tax-Exempt Term Interest Holders

3. Disallowed Depletion

4. Excluded Cost-Sharing Payments

5. Tax on Disposal of Federally-Subsidized Residence

6. Capital Cost Reduction Payments

D. Basis in Pass-Through Organizations

1. Partnerships

a. In General

b. Basis Adjustments

c. Partnership Interest Cash Basis

2. S Corporations

3. Regulated Investment Companies

a. Unit Investment Trusts

b. Regulated Investment Company Exempt-Interest Dividend


5. Controlled Foreign Corporations

6. DISCs

7. Passive Foreign Investment Companies

E. Exceptions to the Adjusted Basis Definition

1. Bargain Sales to Charity

2. Certain Term Interests

3. Certain Annuity Transfers

V. Allocation of Basis

A. Purpose

B. Allocations Among Properties

1. Allocation Among Simultaneously Acquired Properties

a. Trade or Business Assets

b. Land and Depreciable Improvements

c. Land and Growing Crops

d. Personalty

e. Property Acquired in Partial Recognition Transactions

(1) Like-Kind and Similar Exchanges

(2) Involuntary Conversions

(3) Corporate Transactions

(a) Contributions and Distributions

(b) Target Corporation Assets

(c) SEC-Mandated Exchanges

(4) Partnership Transactions

(a) Distributed Properties

(b) Distributed Marketable Securities

(c) Optional Basis Adjustments

(i) In General

(ii) Section 743(b) Adjustments

(iii) Section 734(b) Adjustments

(5) REMIC Transactions

f. Financial Institution Federally Assisted Transactions

(1) In General

(2) Federal Financial Assistance

(3) Basis Allocation

g. Timber Property Eligible for Reforestation Amortization

h. Film and Television Production Costs Eligible for Expensing

2. Allocation Among Divided Properties

a. Real Property

(1) Subdivided Property

(2) Creation of Undivided Interests

(3) Leases

(4) Disposition of Less Than Entire Interest

(5) Carved-Out Rights

b. Charitable Contributions of Property

c. Stripped Bonds

3. Allocation Among Fungible Properties

a. In General

b. Stocks and Bonds

(1) In General

(2) Unified Transactions

(3) Adequate Identification

(a) In General

(b) Confirmation Document Identification for Agent Sale

(c) Confirmation Document Identification for Taxpayer Sale

(d) Securities Held by Fiduciary

c. RIC Stock

(1) In General

(2) Applicable RICs

(3) Shares Acquired by Gift

(4) Average Basis

(5) Double-Category Method

(a) In General

(b) Special Rules for Shares in the Short-Term Category

(6) Single-Category Method

(7) Election

4. Allocation of Basis in Tax-Exempt Organization's Debt-Financed Property

C. Allocation Among Owners

1. Simultaneous Ownership

a. In General

b. Spousal Principal Residence Rule

c. Oil and Gas Properties

(1) Allocation of Partnership Basis Among Partners

(2) Allocation of S Corporation Basis Among Shareholders

2. Sequential Ownership

a. In General

b. Uniform Basis Rules

(1) In General

(2) Disposition of Partial Interest

(3) Property Acquired Before Decedent's Death

(a) Entire Property Included in Decedent's Gross Estate

(b) Portion of Property Included in Decedent's Gross Estate

(c) Property Not Included in Decedent's Gross Estate

(4) Gratuitous Transfers of Remainder Interests

(5) Life Tenant's Disallowed Depreciation Deductions

VI. Timing Issues Involving Basis

A. In General

B. Obtaining and Adjusting Basis

1. In General

2. Partners and S Corporation Shareholders

3. Contingent Debt

C. Recovery of Basis

1. Installment Sales

a. In General

b. Election Out

c. Installment Sale of Depreciable Property to Related Person

2. Partnership Liquidations

VII. Basis Reporting and Record Keeping

A. Reporting Basis

1. In General

2. Low-Income Housing Credit

3. Allocation of Basis Among Purchased Business Assets

B. Basis Record Keeping

1. In General

2. Gifted Property

3. Persons Holding Property with Uniform Basis

4. Spousal Transfers

5. Stock Rights

6. Player Contracts

7. Pass-Through Entity Oil and Gas Property Basis

a. Partnerships

b. S Corporation Shareholders

8. Basis Allocation Among RIC Shares

C. Post-2010 Basis Reporting Requirements

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Finding List of Related Tax Management Portfolios