Property Transactions: Basis & Cost Recovery

Why this topic matters

Every gain or loss calculation starts with basis, and every depreciation deduction starts with cost recovery rules. Taxation and Regulation (REG) Area III (Federal Taxation of Property Transactions, 5–15%) tests basis in purchased, gifted, and inherited property, and the Modified Accelerated Cost Recovery System (MACRS), Section 179 expensing, and bonus depreciation — all updated by the One Big Beautiful Bill Act (OBBBA) of July 2025, whose 2025 provisions became testable on July 1, 2026.

Initial basis

How acquired	Basis
Purchase	Cost: cash + fair market value (FMV) of property given + liabilities assumed + acquisition costs (commissions, title fees, sales tax, installation)
Services received as income	FMV included in income
Lump-sum purchase	Allocate by relative FMVs (land is not depreciable)
Nontaxable stock dividend or stock rights	Allocate the original basis between old and new shares
Like-kind exchange	Substituted basis (see the Gains, Losses & Like-Kind Exchanges topic)
Converting personal-use property to business use	For depreciation and losses: the lesser of adjusted basis or FMV at conversion

Adjusted basis = initial basis + capital improvements − depreciation, casualty losses, and other recoveries of capital.

Property received by gift

Situation	Basis for gain	Basis for loss
FMV at gift ≥ donor's basis	Donor's adjusted basis (carryover) + gift tax paid on the appreciation
FMV at gift < donor's basis (dual basis)	Donor's basis	FMV at date of gift

With dual basis, a sale price between FMV at the gift date and the donor's basis produces no gain and no loss. The holding period carries over from the donor, except when FMV is used as the loss basis (then it starts on the gift date).

Property acquired from a decedent

• Basis = FMV at the date of death (or the alternate valuation date, 6 months later, if the executor elects it) — "stepped up" or "stepped down".
• The holding period is automatically long-term.
• Exception: appreciated property gifted to the decedent within 1 year of death that passes back to the donor (or spouse) keeps the decedent's basis.
• Income in respect of a decedent (for example, unpaid salary, traditional individual retirement account (IRA) balances) gets no step-up.

Depreciation — MACRS

Class	Examples	Method
3-year	Tractor units, certain racehorses	200% declining balance
5-year	Cars, light trucks, computers, office machinery	200% declining balance
7-year	Office furniture, fixtures, most machinery and equipment	200% declining balance
15-year	Land improvements (fences, parking lots), qualified improvement property	150% declining balance
27.5-year	Residential rental property	Straight-line, mid-month
39-year	Nonresidential real property (commercial buildings)	Straight-line, mid-month

• Salvage value is ignored.
• Half-year convention for personal property: half a year's depreciation in the year placed in service and the year of disposal.
• Mid-quarter convention applies to all personal property placed in service that year if more than 40% of the depreciable basis (excluding Section 179 property and real property) is placed in service in the last quarter.
• Mid-month convention for real property.
• The Alternative Depreciation System (ADS) — straight-line over longer lives — is required in some cases (for example, listed property used 50% or less for business).
• Listed property (passenger vehicles and similar) must be used more than 50% for business to use MACRS and Section 179; passenger automobiles have annual depreciation caps.

Section 179 expensing

• Elect to expense tangible personal property (and certain real property improvements such as roofs, heating and air conditioning, security systems, and qualified improvement property) in the year placed in service.
• OBBBA raised the limit to $2.5 million, reduced dollar-for-dollar once qualifying purchases exceed $4 million (2025 amounts, indexed for inflation — about $2.56 million and $4.09 million for 2026).
• The deduction is limited to business taxable income; any excess carries forward indefinitely. It cannot create a loss.

Bonus depreciation

• OBBBA permanently restored 100% bonus depreciation for qualified property acquired after January 19, 2025 (property acquired earlier follows the phase-down: 40% in 2025).
• Applies to new or used property with a MACRS life of 20 years or less (plus qualified improvement property); not buildings.
• No dollar cap and no taxable income limit — it can create or increase a net operating loss.
• Automatic unless the taxpayer elects out, by class of property.
• Order: Section 179 first → bonus depreciation → regular MACRS on the remaining basis.
• OBBBA also created a temporary 100% deduction for qualified production property (certain nonresidential real property used in manufacturing).

Amortization and other cost recovery

Item	Tax treatment
Section 197 intangibles (purchased goodwill, customer lists, covenants not to compete, trademarks, franchises)	Amortized straight-line over 15 years (180 months)
Start-up and organizational costs	Deduct up to $5,000 each in the first year, reduced dollar-for-dollar once costs exceed $50,000; the rest over 180 months
Domestic research and experimental expenditures (new §174A)	OBBBA restored immediate expensing for tax years beginning after December 31, 2024 (small businesses may apply it retroactively); foreign research is still amortized over 15 years
Depletion (natural resources)	Cost depletion (units extracted), or percentage depletion (a statutory percentage of gross income) — take the greater; percentage depletion may exceed basis

How it is tested

• Compute basis for purchased, gifted (dual basis), and inherited property.
• Choose the MACRS class, method, and convention.
• Apply Section 179 limits and bonus depreciation in the correct order.
• Compute start-up cost deductions and Section 197 amortization.