Basis and cost-recovery rules for property acquired, converted, improved, depreciated, or transferred.
This part introduces the property framework used throughout REG. The chapters focus on how assets are measured for tax purposes, how their cost is recovered, and why basis and recovery method change the eventual gain, loss, or deduction result.
Most property questions begin before the sale or disposition. If the starting basis is wrong, later depreciation, amortization, adjusted basis, gain, loss, and character conclusions will also be wrong. REG candidates should treat basis as the running tax measure of the asset, not just as the original purchase price.
| Issue | What it controls | Common REG trap |
|---|---|---|
| Initial basis | The starting point for recovery, adjusted basis, and future gain or loss. | Using fair market value when cost, transferred basis, or substituted basis controls. |
| Basis adjustments | The remaining unrecovered tax investment in the asset. | Forgetting improvements, depreciation, casualty adjustments, or other basis changes. |
| Cost recovery | Timing of deductions through depreciation, amortization, or depletion. | Confusing book depreciation with tax recovery rules. |
| Placed-in-service and use | When recovery begins and which rules apply. | Starting deductions before the property is ready and available for its intended use. |
| Step | REG question to ask | Why it matters |
|---|---|---|
| 1. Identify the acquisition event | Was the asset purchased, exchanged, inherited, gifted, converted, or contributed? | Basis rules depend on how the taxpayer obtained the property. |
| 2. Establish initial basis | What cost, transferred basis, substituted basis, or special rule controls? | Later recovery and gain calculations cannot be correct if the opening basis is wrong. |
| 3. Track adjustments | What improvements, depreciation, amortization, credits, or casualty events changed basis? | Adjusted basis is a running tax measure, not a static purchase amount. |
| 4. Determine recovery method | Is the asset depreciable, amortizable, depletable, or not recoverable until disposition? | Timing differences can change taxable income before any sale occurs. |
| 5. Carry basis forward | How will adjusted basis affect later gain, loss, character, or limitation analysis? | REG often links property measurement to later disposition and entity-tax questions. |
| Checkpoint | Ask before computing | REG tax effect |
|---|---|---|
| Acquisition method | Was the property bought, gifted, inherited, exchanged, contributed, converted, or replaced? | Basis rules begin with the way the taxpayer obtained the property. |
| Cost versus tax basis | Which costs, liabilities, improvements, or special rules enter tax basis? | Book value, fair value, and tax basis may differ. |
| Recovery eligibility | Is the property depreciable, amortizable, depletable, inventory, personal-use, or nonrecoverable? | Recovery method affects timing before any disposition occurs. |
| Adjustment history | What depreciation, amortization, credits, casualty losses, or return of capital changed basis? | Adjusted basis must be current before gain, loss, or limitation analysis. |
| Carryforward effect | Does the transaction create substituted basis, transferred basis, deferred gain, or disallowed loss? | Property rules often move the tax consequence into a later year. |