This article will explain what asset basis is, how it changes, and why asset basis is important in business.
Understanding Asset Basis
The cost of the asset is used to determine the asset basis in business. Capital assets are the main assets that generate value for the company over a long period. These assets include vehicles, buildings, machinery, equipment, and furniture. The term “capitalization” is used to describe the process of purchasing an asset and determining its basis and depreciation instead of writing it off as an expense.
The cost of the asset is used for accounting purposes to show the value of assets on the company’s financial statements. It is also used for tax purposes to determine costs for the purpose of determining depreciation over the asset’s life and calculating capital gains tax when sold.
What Asset Basis Does Not Include
The cost of assets for determining the basis of business assets does not include administrative costs, maintenance and repair costs, minor spare parts, and consumable materials. You may be able to use these costs as expenses for the tax year.
For example, if you purchase a computer system for your company, the basis may include delivery fees, sales tax, and setup fees. It does not include the cost of printer paper or repairing a broken keyboard key.
Basis of Different Types of Assets
The basis of intangible assets such as patents, copyrights, and trademarks is typically the cost to purchase or create the asset. Intangible assets are usually amortized, a process similar to depreciation.
Real estate, also known as property, consists of land and the buildings on it. If you paid property taxes for the seller, you can include that in the basis. The cost of land generally includes costs for clearing, leveling, landscaping, and site preparation.
If you own a home and convert it into business property or rental property, you can begin to depreciate it. The basis for this purpose is the lesser of the market value at the date of conversion or the adjusted basis at the date of conversion.
How Asset Basis Changes
The basis of an individual asset increases and decreases over the time you own the asset, and the basis affects the sale of the asset.
During the useful life of the asset, any improvements you make increase the basis. For example, if you put a new roof on a commercial building, the basis of that building is increased by the cost of the new roof. Other increases in basis include:
- Capital improvements such as a new roof for your business building
- Assessments for local improvements, including water connections and sidewalks or roads
- Restoration of damaged property after a loss due to an accident
- Real estate planning costs
- Legal fees for title work
The basis of the asset can decrease for:
- Casualty loss deductions or theft and insurance reimbursements
- Some composite credits
- Depreciation expenses
When selling a business asset, you must adjust the basis of the asset to determine if there is a gain or loss in value for capital gains tax purposes.
Why Asset Basis is Important
Understanding asset basis and including all aspects of purchasing those assets is important because the basis is calculated differently for different purposes.
The asset basis is used to calculate the depreciation expense of the individual asset. A higher basis results in higher annual depreciation expenses over the life of the asset.
Capital gains taxes depend on the increase in the asset’s price over the original purchase cost or basis. A higher basis can mean lower capital gains tax when selling the asset.
If you determine the basis of the asset through appraisal and records and have a loss due to a business disaster, you can use this basis for both the casualty loss deduction on your business tax return and for insurance purposes. The loss may be calculated differently for each purpose.
The total basis of all capital assets in your company represents a significant part of your company’s value. This value can be used in financial analysis, such as the debt-to-asset ratio. A higher asset value reflects a lower debt-to-asset ratio, indicating the company is not at risk of insolvency or bankruptcy.
Source:
https://www.thebalancemoney.com/what-is-the-basis-in-an-asset-398142
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