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. However, it is not possible to use 1031 exchange proceeds to pay off debt on property you already own, nor can you build improvements on land you already own in a 1031 exchange.Commissioning updates on land that you already hold title to doesn’t qualify as “like-kind”, and can be problematic for uneducated investors.
What you ultimately want is to take the 1031 exchange proceeds, purchase new land and have it built to your specifications, i.e., you obtain the desired physical structure and buy a replacement property of equal or greater 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 case, the property investor would request that the seller raise the price of the property 0,000 – but before closing – construct ,000 worth of improvements to the investment property. Ultimately this investor spends the same amount (0k) to buy a property of the same value.
Finding a replacement property seller who is willing to increase the sales price, and make improvements before closing, may be difficult. Alternately, in our investors case, she can have her QI purchase the investment property on her behalf for k (using an LLC that the Qualified Intermediary owns outright) then construct the improvements to the property using the remaining funds from the exchange.
In other words, the QI holds the property during the construction process, and funds the improvements with the exchange monies. The investor can complete the exchange by receiving the replacement property from the Qualified Intermediary when the improvements are completed.
Keep the following points to in mind about the 1031 Build to Suit exchange. First, the 180-day requirement in order to complete a 1031 exchange does not allow sufficient time for an elaborate Build to Suit. However, it should be enough time to rehabilitate or remodel an existing structure.
Second, the improvements to the replacement property must constitute “real estate” for purposes of a like-kind exchange, i.e., real estate for real estate. Just dumping the building supplies on the location of your property won’t be enough, to constitute “real estate” those materials must be made a permanent part of the structure or affixed into the land.
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.
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