What Is Basis Value?

Basis value is the price of a fixed asset for taxation purposes. A fixed asset's value can be adjusted to help companies take advantage of tax benefits as outlined by the Internal Revenue Service (IRS). In other words, the basis value helps reduce a company's tax burden on the asset when the asset is sold.

Key Takeaways

  • The basis value is the price of a fixed asset for taxation purposes.
  • A fixed asset's value can be adjusted to help companies take advantage of tax benefits as outlined by the Internal Revenue Service (IRS).
  • Basis value helps reduce a company's tax burden on the asset when the asset is sold.
  • Different types of expenses and activities over the life of the asset can either increase or decrease the basis value and ultimately the tax burden from selling the asset.

How to Calculate the Basis Value

Since IRS regulations and the tax code vary from industry to industry, it's best to contact a tax accountant or the IRS to determine how the basis value of a company's fixed assets should be reported. There could be regulations specific to a company's industry whereby a company might be eligible for tax credits or tax deductions that change the basis value of an asset.

As a result, of those deductions or credits, the taxable gain or loss on the sale of the asset will be impacted. For example, real estate assets have different expenses that can increase or decrease the basis value compared to fixed assets such as machinery or equipment.

Generally speaking, the basis value calculation could begin with the original purchase price of the asset. From there, you can increase the basis by adding any amounts that were spent on improving the asset or any legal fees or selling costs associated with the asset. The basis value will likely decrease if you must subtract amounts that you previously claimed as tax deductions, such as depreciation, casualty losses, or theft losses.

What Does the Basis Value Tell You?

Basis value is especially important when it comes to the disposal of an asset since capital gains, and any resulting taxes are driven by the basis value. For a given sale price, the higher the basis value and consequently depreciated book value, the lower the taxable capital gain. Basis value is also used as an asset's base price upon which depreciation and amortization are calculated.

When a company sells a fixed asset, it would ideally like to earn as much money as possible from the sale. However, from a tax standpoint, the company looks for ways to reduce any capital gain from the sale of the asset because the gain is taxable.

Basis value forms the base price for a fixed asset to which capitalized expenses can be added. Capitalized expenses could include the costs of installing or constructing the asset. Adding the capitalized expenses to the basis value increases the value of the asset and decreases the capital gain on the sale of the asset.

As stated above, different types of expenses and activity over the life of the asset can either increase or decrease the basis value and ultimately the tax burden from selling the asset. If a company is constructing an asset, the costs associated with the construction might be able to be added to the basis value. Costs that increase the basis value might include the labor, materials, and permit fees in constructing the asset. Items that might decrease the basis value might include any tax deductions, investment credits, or any rebates to manufacturers.

An Example of Basis Value

Company A has a fixed asset for which capitalized expenses were $50,000, and the asset has a book value (after depreciation) of $100,000 after five years.

  • Basis value is the book value of $100,000 plus the $50,000 in capitalized expenses or $150,000.
  • If the asset is subsequently sold for $130,000 there is a loss on the sale of $20,000 or ($150,000 - $130,000).

However, improperly recording expenses can lead to inaccuracies and over-payment of tax.

  • In our example above, let's say that Company A failed to record the $50,000 in capitalized expenses for the asset. In other words, the basis value is equal to the book value of $100,000 instead of $150,000.
  • If the asset is sold for $130,000, the taxable gain is now $30,000 or ($130,000 - $100,000).

Since the capitalized expenses were not properly recorded, the company paid taxes on a capital gain of $30,000 from the sale of the asset instead of possibly being able to write off a loss.

The Difference Between the Basis Value and Market Value

The fair market value of an asset shouldn't be confused with the basis value. The fair market value of a business or asset is the estimation of the price that would be paid to the owner upon a sale. The formula for determining a fair market value includes business worth and assets in the current financial markets.

Determining fair market value can be challenging since the only way to prove the true value is to sell the business or asset. Basis value, on the other hand, is the base price of a fixed asset to which capitalized expenses are added and provides the value of the taxable gain from selling an asset.

Limitations of Using the Basis Value

While the accounting departments of large companies closely track the basic values of their fixed assets, small companies with limited resources such as full-time accountants may face challenges in ensuring the basis value of their assets is accurate.

Another limitation in the basis value calculation can stem from the need to stay abreast of changing tax laws. If a company's accountants inaccurately calculate the value of the assets, the basis value and the resulting tax calculations will be wrong.