How Exactly do Build-to-Suit Construction Exchanges Work?

In a normal real estate transaction, if John Doe sells a property worth $500,000 and purchases a new piece of land with nothing on it for $100,000, the IRS takes the position that once John Doe owns that land. His exchange is complete and any improvements that he makes on top of that land that he now already owns won't count towards his 1031 exchange.

A Work-Around

A work-around for this type of situation is a mechanism under rev proc 2037 that allows the qualified intermediary to form an LLC and buy the new land using $100,000 of John Doe's exchange funds and holds title to that dirt during the remainder of the 180 day exchange period.

During this time, improvements can be constructed on that new land and still count towards the 1031 exchange. So if you can build up quickly, you can potentially construct another $400,000 property value on top of that dirt so that you receive replacement property of equivalent or greater value. Remember, in a 1031 exchange, you want to buy property of equal or greater value so you continue your investment. You want to reinvest all of your equity, your proceeds, and to the extent that you pay off debt on the old property you want to offset that debt either with the replacement property itself or cash from your own pocket.

Constructing Improvements

A build-to-suit exchange is a great way to construct the improvements to your specifications and get new property that qualifies for 1031 exchange treatment, but you only have 180 days total so make sure you have all of your ducks in a row and ready to go before you begin the process.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

Can I do a Build-to-Suit 1031 Exchange on a Property I Already Own?

The idea behind the 1031 exchange is to encourage investment into properties that you don't already own. To that end, the IRS and Congress say to taxpayers “you can't construct improvements on property that you already own” because they don't view that as an “exchange.” So how do you tackle this potential 1031 exchange issue?

Third Party Seller

The first way to resolve this problem is to NOT construct the improvements on the land that you already own. Instead, go out and buy something from a third-party seller and construct improvements on that property through your intermediary (or exchange accommodation title-holder also referred to as an “EAT”).  This is the simplest and cleanest way to do a Build-to-Suit Exchange.

Private Letter Ruling

There is however, a favorable authority (a private letter ruling) where a REIT had purchased property through a somewhat dissimilar but related subsidiary and then wanted to exchange into improvements upon the land owned by its dissimilar but somewhat related subsidiary using a long-term ground lease with an exchange accommodation title-holder. They constructed the improvements on new estate or separate interest in the property. So there are ways to fashion a build-to-suit on land owned by a somewhat related and dissimilar entity, but we need to make sure that it's done properly and according to that authority (that private letter ruling), which is only really authoritative to the taxpayer that requested it. Nevertheless, this is illustrative of the IRS’ tax position.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

A Primer on 1031 Build-to-Suit Construction Exchanges

A construction improvement exchange is a unique type of 1031 exchange that allows taxpayers to defer their capital gains tax, while exchanging into a property that fits their needs. This article is focused on the 1031 construction exchange – what it is and when it can be beneficial for taxpayers looking to defer gains on the sale of real estate.

Build-to-Suit Construction Exchanges

A construction exchange (also known as a build-to-suit exchange) is a variation on the typical 1031 real estate exchange that allows the person doing the exchange to construct improvements to their replacement property before exchanging into it. Construction improvement exchanges are great because they allow the exchangor to exchange into a replacement property that fits their needs better than the existing property.  Be aware that any construction  needs to be completed within the typical 180 day like-kind exchange period.

The Importance of Involving a Qualified Intermediary

Construction exchanges are often more complex than typical forward like-kind exchanges. That makes it even more important to hire a qualified intermediary for your exchange. A qualified intermediary is a 1031 exchange professional whose job it is to facilitate like-kind exchanges. When you hire a qualified intermediary they will prepare all of your like-kind exchange documents, answer all of your questions, and advise you so that you are fully prepared when you get to the closing table.

1031 Construction Exchanges in Minnesota

For help with your construction improvement exchange, don’t hesitate to contact us today. The team at CPEC1031 has decades of experience working on commercial transactions across the country. Depending on your situation, a 1031 exchange could help you avoid a significant tax bill when you sell your property. Contact us today to learn more about the tax-saving benefits of a 1031 exchange.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

What to Do if Construction Isn’t Done by the 180 Day 1031 Exchange Deadline?

In a build-to-suit exchange you are racing the clock to construct like-kind improvements so that the value of the acquired land plus the value of the partially completed improvements exceed the value of your relinquished property. By the end of your 180 day exchange period, you want to have received the replacement property of equal or greater value than what you disposed of. But what if construction doesn't finish by the end of your 180 days?

Uncontrollable Variables

The problem with construction is that there a lot of variables that are outside of your control, such as:

• Supply Issues

• Work Issues

• Economic Issues

• Permitting

• Licensing

• Weather

All of these factors can hurt your ability to manufacture improvements within the exchange period.

Incomplete Construction

So the question arises: what if construction isn't fully finished? Or what if it isn't finished enough so that you've received a replacement property of equivalent value?

If you don't continue your investment into a property of equivalent or greater value within the hundred and eighty days, you may recognize some gains to the extent you've received a lesser valued property.

Partial Tax Deferral

But even that may still give you partial tax deferral. It's a factor of how low your basis was in the old property to determine how great your victory may be, even if it's just a partial victory.

If you're thinking about doing a build-to-suit we suggest you get planning early and have all of your contractors, permits, and plans in place perhaps even before you dispose of the relinquished property so that you can win the race against the 180 day clock.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

A Brief Explanation of Construction / Improvement 1031 Exchanges

When you're doing a 1031 exchange you’ve got to find a replacement property. Wouldn’t it be awesome if you could build your replacement property exactly to your own specifications so you get exactly the property that you need and want?

Build-to-Suit Exchanges

A build-to-suit exchange may be the trick that you need to use to complete your exchange and get exactly the property you want. This is the way it works - you sell the relinquished property and the proceeds come to the intermediary. Then you find your piece of raw land or ugly duckling - some property that needs a lot of rehab work (could be an existing building or rental home with extensive deferred maintenance) and you sign a purchase agreement on it at the best and lowest price that you can get it.

But rather than having you close on that replacement property (because your exchange would be over once you received it), you instead have the qualified intermediary form an LLC and the intermediary buys the replacement property by and through this LLC. The qualified intermediary then holds title to the replacement property during the 180 day exchange period – exhausting the exchange funds that are held by the intermediary to fund the improvements.

Further, the improvements can be funded by either third party financing or additional cash advanced by the taxpayer. The idea is that you use all this time during the 180 day period to construct and remodel and fabricate real property improvements that count towards the 1031 exchange so that when the taxpayer receives this newly constructed replacement property, ideally they’re receiving a property of at least equal or greater value and equity as the property they gave up.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved