Pursuant to Internal Revenue Code section 1031, taxpayers are allowed to defer the gains realized on sales or exchanges of real property if the exchange meets the requirements of the provision. These benefits will be allowed only to real property held for productive use in trade or business or for investment if the properties subject to the exchange are also of “like-kind” by their nature. In order to understand the benefits of a like-kind exchange (or “1031 exchange”), a taxpayer should have a fundamental understanding on basis because basis management is a fundamental component in like-kind exchange planning.

BASIS

Basis is the amount of a person’s investment in a particular asset. The types of assets that are subject to basis calculations include real estate, securities, intangible assets, and tangible assets ranging from inventory to physical possessions. Depending on the type of asset in question, there are numerous factors that can affect the value of its basis. As a starting point, the first factor under consideration is the amount the person paid to acquire a particular asset. This is otherwise known as the cost basis of an asset. Generally, costs that are associated with a purchase, such as legal fees, commissions, closing costs and taxes, are adjusted to increase the basis of the asset.

Adjusted Basis

Since this article primarily focuses on the basis of real property, other factors that can affect the adjusted basis of real estate assets include improvements and depreciation. Adjusted basis can be calculated by the cost basis of the asset increased by any improvements less any depreciation deductions that may or may not have been taken throughout the course of the useful life of the asset. Improvements, such as new construction of a guesthouse, are additions to the property that did not exist before, which thereby increase the adjusted basis of the asset. However, mere repairs such as remodeling of a bathroom are not deemed improvements and consequently do not increase the basis of that asset.
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