How to Compute Adjusted Basis in Like-Kind Exchange

Delay capital gains taxes on an investment property with a like-kind exchange.

Delay capital gains taxes on an investment property with a like-kind exchange.

You and your spouse can delay paying taxes on the sale of an investment property by exchanging it for another investment property. This savvy investment move is called a like-kind exchange, or 1031 exchange, and allows you to delay your tax bill until you sell the new property. You need to know the adjusted basis of the property you give up in the exchange to figure various items, such as your capital gain and the cost basis of the property you receive, which are items you must report to the Internal Revenue Service.

Add together the closing costs you paid to acquire the investment property you are giving up in a like-kind exchange. Closing costs include items such as legal fees and brokerage commissions but do not include fees for obtaining a loan. For example, assume you paid $5,000 in commissions and $5,000 in other closing costs. Add $5,000 to $5,000 to get $10,000 in total closing costs.

Add the closing costs to the price you paid for the investment property you are giving up to determine the property’s cost basis. In this example, assume you paid $500,000 for the investment property, so you get a $510,000 cost basis.

Add the amount of any capital improvements you made to the property to your cost basis. Capital improvements are additions you make to the property that last longer than one year, such as a new room. In this example, assume you spent $50,000 to add a new room to the property. Add $50,000 to $510,000 to get $560,000.

Subtract the total amount of depreciation you have taken on the property from your result to calculate the adjusted basis of the property you are giving up in the like-kind exchange. Depreciation is a tax deduction you take annually to account for wear and tear on the property. Continuing with the example, assume you have taken $100,000 in total depreciation on the property. Subtract $100,000 from $560,000 to get a $460,000 adjusted basis of the property.

Tip

  • Consult an accountant when completing a like-kind exchange. If you fail to properly follow all IRS requirements for your specific situation, you might get stuck with an unexpected tax bill.

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