A tax basis is the value of an asset used for computing a gain or loss when the asset is sold. A taxpayer is liable for capital gains tax if the asset is sold at a price higher than its basis. If the basis is higher, the tax liability is lower because there is less gain to be taxed.
In most situations, the basis of an asset is its cost to you (i.e. the amount you paid for it). However, there are special rules that apply in several situations. For example, if you receive an asset from a decedent (e.g. by will or through inheritance), the basis is the fair market value on the day of the decedent’s death in most cases. So, you acquire a “step-up” in basis. Assuming the value of the asset increased after the original owner acquired it, you will only be liable for capital gains tax on the appreciation of the asset during your time of ownership of the asset.
In addition, the basis can change over time. For example, the cost of improvements that add to the value of the property increase the basis, and allowable depreciation decreases the basis. When such changes occur, your basis is called an "adjusted basis."
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