That means that 100% of the proceeds of the sale of the property must go towards the purchase of the new property, and not towards things like improvements on that property.
But what if an investor wants to purchase a property that is lower in value than their relinquished property and then improve that property to increase its value?
In a build to suit 1031 exchange, often called “Improvement 1031 exchanges” or “construction 1031 exchanges”, you can sell your relinquished property and use the proceeds to both buy and improve your replacement property. These are more complex transactions and typically require legal help, but if structured correctly they can be a powerful tool.
When structuring a build to suit exchange, the investor must either choose to do a forward exchange or a reverse exchange. In either scenario the investor cannot hold title to the property while the improvements are being made. In order to accomplish this, the investor must hire an exchange accommodation title holder, or “EAT”. This is a separate entity that purchases the replacement property on behalf of the investor. The EAT is usually a qualified intermediary working for a fee.
The EAT will set up a “parking arrangement” with the investor that outlines what improvements are to be made to the property, what funds will pay for those improvements, and what timeline will be in place to ultimately transfer the property to the investor. The investor will still have to pay for the improvements to the property, typically in the form of a bridge loan or cash, and effectively gets “paid back” with the exchange funds.
The EAT and parking arrangement are two of the biggest hurdles. After that, the typical 1031 exchange rules are in effect. They first decide on the property and improvements that are to be made, and then they identify the final value of both for their exchange purposes in the first 45 days after they close on the sale of their relinquished property. And all of the improvements must be completed and the property title must be transferred to the investor no later than 180 days after the sale of their relinquished property.
As mentioned, build to suit 1031 exchanges are more complex than a typical 1031 exchange. That should not deter an investor from attempting to complete one, however it is critical to seek the right advise while engaging in this type of exchange.
Related Articles
Market Update
The 1031 exchange is a powerful tool for real estate investors, but did you know in the past it has...
Market Update
As most investors know, every state has its own unique tax structure. Federal taxes are uniform...