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1031 Exchange

Many real estate investor are aware of the money saving power of a 1031 exchange, and how it allows one to transfer their captial gains taxes from the sale of a property, into another like-kind property. Nevertheless, you cannot use the money from a 1031 exchange to pay off a property that you already hold title to - or build improvements on any a piece of land that you have used in a tax exchange.One common pitfall for inexperienced investors is attempting to make improvements on land that they already own, but this does not qualify for 1031 status.

Ideally, you would take the money that was collected during the exchange and build to suit on the new land yourself, i.e., you secure the desired property and buy another investment property that is equal to or greater than in value. So how is it possible for you to do this?

There is an option that is referred to the “Poor Man’s” build to suit, in which the buyer asks the seller to make improvements to the replacement property before the close. For example, a taxpayer sells her property worth 0 thousand dollars, and wants to purchase a replacement property worth 0 thousand dollars or greater.  But the raw land she desires is only worth thousand dollars, which will obviously not completely qualify for a like-kind exchange and thus, no deferred tax gain.

In this example, the buyer asks the seller of the replacement property - to raise the sales price up to one-hundred thousand dollars, then before the close, building in ninety-thousand dollars worth of improvements to the said property. In the end, she will be purchasing property of equal value (100 thousand dollars).

It might be difficult to find a seller who is willing to increase the price of the property - in order to make improvements to it before selling it to you.  Another option in our investor’s case is to have the qualified intermediary (QI) buy the replacement property for ten thousand dollars, take title in a LLC wholly owned by the QI and use the remaining exchange monies to construct improvements to the property.

So likewise, your QI can fund the improvements during their construction, holding the property for you and paying for everything with the proceeds from the exchange. When the improvements to the replacement property are finished, the investor can complete the exchange by receiving the property from the QI.

Consider the following things when you attempt to use a build to suite exchange. 1st, the 180 day period that is allotted to you to complete your exchange, won’t give you adequate time for a complex build to suit.  But, this should be enough time to rehab and update an already standing building.

Secondarily, to be considered an actual “like kind” exchange, any of the improvements to the replacement property must constitute “real-estate”, i.e., real estate for real estate. Merely dumping materials on the property will not suffice; the materials must be constructed or affixed into the land and be made a permanent part of the structure to constitute real estate.

Keep the foregoing in mind and you can avoid any pitfalls and get all of the tremendous tax benefits of a 1031 exchange that is build to suit.