One of the IRS hot buttons lately is the cost basis. That applies to not only the basis of your stock and bond investments but also the much more diverse real estate holdings and private investments in partnerships, corporations, joint ventures, LLC’s and even trusts.

Sum years ago the IRS started requiring broker to track the basis of the stock purchases and report both the sales and costs on the annual form 1099-B to individual taxpayers. They do not necessarily track the basis for non-individual holdings.

Additionally, if you have held stock and bonds for a long time or changed the broker that is holding them that new broker may not have the proper basis. I have clients that have no idea of how to read the broker statement, which is due in part to the brokers not wanting the client to figure out 1) what their ROI is and 2) the cost of the administration. Many accountants have programs to track this information and there are companies that (for a fee) will track you stock and bond activity.

But now let’s get to the more difficult holdings that are harder to track and monitor.  You purchase a piece of real estate, at closing you get a closing statement or a HUD-1 statement reflecting the closing of the property being transferred to you. It typically has your gross purchase price plus a whole list of costs and credits some of which are currently deductible and others that should be capitalized as part of the basis. As a note, your local bank and county assessor do not usually have this information. In additional you may have incurred out-of-pockets cost for appraisals, inspections, title reports, title insurance, investment analysis that should be capitalized. Depending on the nature of the real estate you may subsequently incur costs such as interest, insurance and property taxes should either be capitalized or expensed in the current period. You also incur costs for construction/development, improvements, repairs and replacements, and tenant improvements that may be either capital or expense depending on the nature and timing of the expenditures.

If you buy real estate to be developed the land cost (non-depreciable) is usually determined, but if you purchase a developed property you must allocate between the building and improvements (depreciable) and the non-depreciable fixed cost of the land.

Then every period you have depreciation (both book and tax) that reduces the carrying basis. Every year I have clients tell me that “well we just won’t claim depreciation this year”. Unfortunately, the tax code says “allowed or allowable” so even if you didn’t claim it the IRS could deduct for it and if it was a closed year you couldn’t even go back and get the deduction but would lose it as basis, thereby increasing the gain on the sale. Each year there are decisions on whether certain expenditures are improvements/betterments to be capitalized or routine repairs and replacements.

If you were to sell the property this afternoon, would you be able to track and prove (to IRS satisfaction) the remaining cost basis to calculate your gain for tax purposes.

The key is to retain the records and worksheet or other record tacking the basis that is kept current.

We have only scratched the surface on the topic as I will cover a number of related and continuing issues in Part II.