Build To Suit Exchanges Rock For Investors
If you are an investor, you may be aware of the section 1031 exchange rule, and how it can be used to defer the capital gains taxes on the sale of an investment property, into a replacement property of equal or greater value. 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.
The 1031 exchage proceeds would ideally be used to make the build to suit to your specifications on the new land, 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?
One option, called, “the Poor Man’s Build to Suit”, is to ask the seller to make improvements to the property before closing. An investor, for example, sells an investment property worth 0,000 and intends to buy a replacement property worth the same (or greater).But the replacement property is only worth about k, which isn’t enough to qualify as a “like kind” exchange, and therefore not “transferable” under 1031.
In this scenario, the investor would ask the replacement property seller to increase the sales price to 100 thousand dollars, and before closing, the seller will have to construct 90 thousand dollars worth of improvements to the property. In the end, she will be purchasing property of equal value (100 thousand dollars).
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. When the improvements to the replacement property are finished, the investor can complete the exchange by receiving the property from the QI.
These are important things to consider when you are conducting 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. And existing structure can hopefully be updated and rehabbed within this time.
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. Simply dropping off some building materials on location is not acceptable; to constitute “real estate” your supplies must literally be attached to the building as a permanent part of the structure or affixed into the land that it is on.
Stay focused on the final outcome, avoiding any difficulties, and you’ll get all of the great benefits of a build to suite tax exchange.
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Tags: 1031 exchange, 1031 tax exchanges, capital gains taxes, investment property
