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Cost Basis

Cost basis refers to the original value or cost of a property for tax purposes. In simpler terms, it’s what you initially paid for the property, including the purchase price and any related costs (such as renovations or improvements) that you’ve added to the base value over time.

When you sell the property, the cost basis is used to calculate capital gains or losses. If the property sells for more than the cost basis, you realize a capital gain, which may be subject to capital gains tax. If it sells for less than the cost basis, you realize a capital loss.

A 1031 exchange, also known as a like-kind exchange, allows an investor to defer paying capital gains taxes on an investment property when it is sold, as long as another “like-kind property” is purchased with the profit gained by the sale of the first property.

For example, if an investor originally purchased a property for $500,000 and then spent an additional $50,000 on renovations, their cost basis would be $550,000. If they sell the property for $700,000 and reinvest the proceeds into a like-kind property through a 1031 exchange, they would only owe capital gains tax on the difference between the selling price and the cost basis ($700,000 – $550,000 = $150,000).

When you execute a 1031 exchange, the cost basis of the property you sell is transferred over to the new property you acquire. In other words, the cost basis of the new property becomes the cost basis of the old property. This is why you’re able to defer the capital gains tax – because, for tax purposes, it’s as if you’re continuing your investment in the same property.

However, it’s important to note that while a 1031 exchange allows you to defer capital gains taxes, it doesn’t eliminate them. The deferred tax will be due when the new property is sold unless another 1031 exchange is performed.