Still making the top of every Enrolled Agent list of confusing matters to elucidate for taxpayers is basis identification. Like explaining baseball to someone from another planet, you know what is happening but describing it becomes overwhelming. Fortunately, experienced EAs eventually develop simplified summaries about the many facets of basis.
The initial step in an Enrolled Agent course discussion of basis is fairly easy. Acquisition cost forms the basis for most capital assets. From here the subject becomes more mysterious. Firstly, basis is reduced by depreciation. An abridged explanation conveys that depreciation is a tax benefit taken by deducting some of the cost. Therefore, only the remaining cost is the basis used in a capital gain calculation.
A helpful reminder to the dilettante taxpayer is that basis is the deduction taken from sales proceeds when determining a taxable gain. Taxpayers can deduct cost via depreciation or subtract cost from sales proceeds. They cannot apply both techniques for deduction of the full cost twice. The Enrolled Agent preparation aid of diagramming this process is extremely beneficial for unknowledgeable taxpayers.
This issue reaches the heights of complexity when taxpayers acquire capital assets in ways other than purchase. A particularly common case is an inherited item. Absent occasional Congressional meddling with the estate tax laws, the inheritor of property has a basis that is the value of the item on the decedent’s date of death. This is the step-up in basis as detailed in Enrolled Agent exam prep. Whatever gain in value was incurred by the deceased person evaporates for the estate beneficiary.
Of course, the reverse can happen as well. The beneficiary receives a lower basis than the decedent’s original cost when the property value has declined since the purchase date. They key fact from Enrolled Agent training that unskilled taxpayers often fail to appreciate is that actual date-of-death value is the new basis. Substitution of appraisal district value as of January 1 is not allowed – unless the decedent died on New Year’s Day.
Alternative valuation dates are prohibited by the IRS. Enrolled Agents must advise their clients to capture asset values listed on estate tax returns or probate schedules. Grouping of nearly identical items is acceptable, but the result should usually cause one of twenty similar property units to have one-twentieth of the total basis.
Several nuances about inherited assets are uncovered during Enrolled Agent education courses. Many unusual situations can baffle taxpayers, so avoiding further bewilderment is a delicate matter. For example, US citizens and residents must have a record of basis for property located outside the US – even for properties inherited from nonresidents.
The basis for an inherited asset located overseas is the date-of-death value. The step-up rule still applies despite the fact that a nonresident decedent is not subject to US estate tax assessment on the property value. Gathering the correct value might entail a considerable burden. But, possessing that measure is crucial. The beneficiary who is a US citizen or resident needs the basis figure when selling the property. Citizens and residents are eventually responsible for capital gain tax upon the sale of foreign holdings. If overseas property is never sold, estates of US citizens and residents include foreign assets in their estate tax returns.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.