Investors – Heard About a Build To Suit 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. But it isn’t possible to use the money from your exchange to pay the debt on an investment property that you already own – and likewise, you can’t build improvements on land that you own with a 1031 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.

The 1031 exchage proceeds would ideally be used to make the build to suit to your specifications on the new land, i.e., you get the built structure you want and purchase a replacement-property that is worth the same amount (or greater value). So how does one accomplish 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).Although the vacant land she wants to buy is worth only ten-thousand dollars, which doesn’t fully qualify for a “like-kind” exchange, thus making an exchange impossible.

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. After all is said and done, she’ll purchase a replacement property or the same value, which is 0,000.

Finding a seller (of the property) that is willing to charge more, then make improvements to it before closing – may not be all that easy to find.  One other approach to this is to have the QI (or qualified intermediary) purchase the replacement property for ,000 – then take the title into an LLC that is owned exclusively for the purpose of a 1031 exchange, and use the remaining money from the exchange to make improvements to the replacement property.

Put another way, your qualified intermediary will hold the property during it’s improvement process, funding them with the money from the exchange. The investor can complete the exchange by receiving the replacement property from the Qualified Intermediary when the improvements are completed.

These are important things to consider when you are conducting a build to suite exchange. First of all, the one hundred and eighty day requirement allowed to complete a 1031 exchange, will not provide you with enough time for a “fancy” 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.

Keeping your savings in mind, be careful to stay away from any potential problems, to get the money saving tax benefits of a build to suit exchange.