Basis of Acquired Property and Holding Period (IRC §1012, §1014, §1015, §1016)

The initial basis of property acquired by purchase is generally the taxpayer’s cost, including the purchase price and amounts paid to acquire and place the property in service, such as sales taxes, freight, installation, testing, and certain closing costs for real property.

Gifted property (IRC §1015). When property is received by gift, Internal Revenue Code §1015 generally provides a carryover basis equal to the donor’s adjusted basis for determining gain, subject to the dual-basis rule when the fair market value at the date of gift is lower than the donor’s basis. Under the dual-basis rule, the donee’s basis for gain is the donor’s adjusted basis, while the basis for loss is the property’s fair market value at the date of gift; accordingly, a subsequent sale may produce gain, loss, or neither depending on the sale price. If the donor pays gift tax attributable to the appreciated portion of the gifted property, a portion of that gift tax may increase the donee’s basis. Because these rules are fact intensive, taxpayers should document the donor’s basis, acquisition date, and the property’s fair market value at the date of gift.

Inherited property (IRC §1014). Property acquired from a decedent generally receives a new basis equal to the fair market value at the date of death under IRC §1014, subject to alternate valuation rules and estate-administration adjustments. The step-up (or step-down) in basis typically eliminates built-in capital gain at death, so beneficiaries should retain valuation evidence used in estate settlement to substantiate the date-of-death basis.

Over time, basis is adjusted under IRC §1016 to reflect capital improvements and certain additions that increase basis, and cost-recovery deductions, casualty losses, and other statutory adjustments that decrease basis. Because adjusted basis is central to measuring taxable gain or deductible loss, taxpayers should retain records that document acquisition cost, dates of acquisition, donor basis information when applicable, improvements, depreciation schedules, and any basis adjustments.

Holding period rules affect the character of gains. When a donee uses the donor’s basis for gain purposes, the donee generally tacks the donor’s holding period to determine whether a subsequent sale qualifies for long‑term capital gain treatment. When basis for loss purposes is the fair market value at the date of gift, the donee’s holding period begins on the date of the gift.

Cost Recovery

Depreciation (IRC §168) – Tangible assets used in trade or business

Tax law allows recovery of the cost of qualifying tangible property through periodic deductions. The Modified Accelerated Cost Recovery System (MACRS), set out in IRC §168, prescribes recovery classes, depreciation methods, and conventions for most property placed in service after 1986. MACRS assigns property to recovery classes such as three, five, seven, 10, 15, and 20 years, and designates 27.5 years for residential rental property and 39 years for nonresidential real property. Taxpayers apply the method and convention specified for the property class unless an alternative is elected where permitted.

Key expensing and acceleration rules include the Section 179 election, which allows immediate expensing of qualifying tangible personal property up to an annual dollar limit subject to phase‑outs, and bonus depreciation under IRC §168(k), which permits an additional first‑year deduction for eligible property in specified tax years. The availability and percentage of bonus depreciation vary by year, so practitioners should verify current law when planning acquisitions.

Conventions determine the portion of depreciation allowable in the year property is placed in service and in the year of disposition. The half‑year convention applies to most personal property, the mid‑quarter convention applies when a large share of property is placed in service late in the year, and the mid‑month convention applies to real property.

Section 179 Deduction (§ 179): This provision allows taxpayers to elect to deduct the full cost of certain new or used tangible personal property (such as equipment and software) purchased for use in their trade or business in the year it is placed in service, rather than depreciating it over several years. There are annual limits on the amount that can be deducted under Section 179, and the deduction is phased out for taxpayers with total qualifying property exceeding a certain threshold.  

Bonus Depreciation (§ 168(k)): For certain years, the tax law has allowed for “bonus depreciation,” which permits taxpayers to deduct a significant percentage (e.g., 100% for property placed in service between September 28, 2017, and December 31, 2022, with a gradual phase-down thereafter) of the cost of qualifying new or used property in the year it is placed in service. This is in addition to any Section 179 deduction and regular MACRS depreciation.

Recovery Periods: The IRS has established various recovery periods for different classes of property. Some common examples include:

• 5-year property: Includes computers, office equipment, and certain vehicles.
• 7-year property: Includes office furniture, fixtures, and equipment.
• 27.5-year property: Residential rental property. 
• 39-year property: Nonresidential real property (e.g., office buildings, retail stores).

Depreciation Methods: MACRS uses different depreciation methods, including:

• 200% Declining Balance Method: An accelerated method where a fixed rate (double the straight-line rate) is applied to the property’s declining book value.
  150% Declining Balance Method: Another accelerated method using 1.5 times the straight-line rate.
• Straight-Line Method: The cost of the property is deducted in equal amounts over its recovery period.

Conventions: MACRS also specifies conventions that determine how much depreciation can be claimed in the year of acquisition and the year of disposition:

• Half-Year Convention: Applies to personal property and allows for one-half of the normal depreciation for the first year, regardless of when the property was placed in service. The remaining depreciation is claimed over the remaining recovery period, with the other half taken in the year of disposal.  
  Mid-Month Convention: Applies to real property and treats all property placed in service or disposed of during any month as if it were placed in service or disposed of in the middle of that month.
• Mid-Quarter Convention: Applies to personal property if more than 40% of the total basis of such property is placed in service during the last three months of the tax year.

Amortization (§ 197) – Intangible property used in trade or business

Certain intangible assets acquired in a trade or business are amortizable under IRC §197 and are generally amortized over a 15‑year period beginning in the month of acquisition. Section 197 intangibles include goodwill, going concern value, covenants not to compete, and certain other purchased intangible assets. Correct classification between §197 and non‑§197 intangibles is important because different tax rules may apply.

Depletion permits recovery of the cost of natural resources as they are produced or extracted. Taxpayers compute depletion using either cost depletion, which allocates basis over estimated recoverable units, or percentage depletion, which applies a statutory percentage to gross income from the property subject to statutory limitations. Eligibility and method selection depend on the type of resource and statutory rules.