In your work as a real estate investor, one thing is clear: you can’t handle the intricacies of all the necessary tax processes on your own. Working with the buying and selling of multiple investment properties is difficult, and it can lead to some fairly hefty unintended tax consequences if you’re not careful (and sometimes even if you are careful). The 1031 tax exchange was designed to help investors successfully manage tax-related issues – but working with the tax specifics that arise in many investor situations has never been and will never be easy.

One way that taxes and 1031 exchange transactions collide is when it comes to the idea of basis. For your purposes as an investor, specific questions about how basis will affect your 1031 exchange are definitely best left to your tax professional. It’s also important, however, that you put some time and energy towards ensuring that you have a basic understanding of how the idea of basis can affect your 1031 tax exchange so that you are not caught off-guard by the issues at hand.

To put it simply, basis plays into your 1031 tax exchange in the way that gain and exchange values are calculated. When you sell your relinquished property, the basis that you once held in that property is transferred to the replacement property that you then purchase. At a later date, when you sell that second property in a standard taxable transaction, your capital gain will be figure off the basis that you have in the property.

For many investors, considering basis in this manner means taking a different viewpoint on the capital gain you have been amassing. As noted above, however, it is important to listen to the advice of your tax professional when it comes to basis and figuring capital gain: the guidance provided by this professional will be invaluable to your ability to enact a legal, profitable 1031 exchange.

Another way to think about it is to consider that your eventual taxable capital gain can be described as the difference between the eventual sales prices of the property and your adjusted basis. The idea, then, is that you need to look at the basis included in your current 1031 exchange with an eye towards the future: how will you eventually be taxed on your gains?

If you originally have $50,000 in basis on your replacement property, you might increase the basis to $100,000 over a number of years through various improvement projects. If you then sell that property in a taxable transaction for $200,000, then, you’ll have a capital gain of $100,000 on which to pay taxes. Remember: always consult with your tax professional before making any sales or exchanges.