The basis in a property acquired in a qualified Section 1031 Exchange is reduced by deferred gain and becomes the substitute basis.  For example, if the market value of property given up is $200,000, and the basis in that property was $75,000, then realized gain equals $125,000.  Assume the market value of property acquired through a tax-deferred exchange is $350,000, then subtracting the unrecognized gain of $125,000 equals the substitute basis of $225,000.  The effect of this adjustment to basis is to build in the deferred $125,000 gain into the property acquired.  If the new property were sold the next day for $350,000, a $125,000 gain would be reported.