If you’re starting to dip your toes into the world of business and accounting, then one thing you need to know about is adjusted basis, especially if you primarily deal with assets. Depending on how long you’ve been in the industry, you’ve probably heard of this term before. If you haven’t yet, that’s completely fine too—that’s why you’re here.
In this article, we’ll learn about what an adjusted basis is, how to calculate, and other related information that could help make things easier for you.
What Is Adjusted Basis?
When talking about adjusted basis, this refers to any changes made to the original recorded cost of an asset after it has already been owned or acquired. Depending on the difference between your adjusted basis and how much you plan on selling the asset, that’s how much capital gains tax you’ll pay or how much capital loss you’ll have. If your basis is high, then that means you’ll pay less in capital gains tax if or when you plan on selling the asset. Some adjustments could end up increasing your asset’s basis, but some could reduce it. Generally, this isn’t a good thing when tax time rolls around.
When Does Adjusted Basis Occur?
Now that you have a good grasp of what adjusted basis is, when does it occur? There are three factors to keep in mind:
- Sometimes, the cost basis of a security (e.g., stock) can be adjusted when specific events occur. For instance, if you pay dividend via additional stock, this causes an adjustment in the cost basis of the initial shares. The cost basis of the aforementioned initial shares will also experience a form of adjustment when a stock split or a capital distribution occurs. If a dividend is paid in cash, however, this will not cause an adjusted basis.
- If you (or a company) owns an asset like a house or perhaps heavy machinery, you can claim depreciation because of wear on tear on the asset. If you do decide to claim depreciation, the asset’s cost basis also changes to reflect this. On the other hand, if an asset undergoes improvement instead of depreciation, this could also lead to a basis adjustment.
- If someone passes away, it’s common knowledge that their assets would be passed on or given away to those who were special to them. After undergoing the right death protocols, the inherited assets receive a step-up in basis. In other words, all the assets given away to the heirs will receive an adjusted basis that will have the same value as the date of the initial owner’s passing. When this happens and the heir decides to sell the assets, they don’t have to worry about major tax consequences.
How to Calculate It
If you’re interested in knowing how to calculate an asset’s adjusted basis, take the asset’s purchase price and either add or subtract any changes made to its value. Let’s use an example: imagine that you bought an asset worth $10,000, but you decided to sell it one year later after having registered $500 in depreciation as well as spending $1,000 on enhancements. In this case, the asset you initially bought for $10,000 would have an adjusted basis of $10,500. Why? Because $10,000 – $500 + $1,000 = $10,500. It’s as simple as that.
We hope that you were able to learn something from this article. Of course, always consult with a tax professional if you want the best and most updated news and trends regarding corporate finance and accounting.