Investors - Do You Know What A Build To Suit Exchange Is?
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.
Ideally, you would take the money that was collected during the exchange and build to suit on the new land yourself, 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 can you 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. For example, an investor (after selling her investment property) - wants to buy another property to replace it - for an equal or greater value. 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 example, the buyer asks the seller of the replacement property - to raise the sales price up to one-hundred thousand dollars, then before the close, building in ninety-thousand dollars worth of improvements to the said 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. Another option in our investor’s case is to have the qualified intermediary (QI) buy the replacement property for ten thousand dollars, take title in a LLC wholly owned by the QI and use the remaining exchange monies to construct improvements to the property.
So likewise, your QI can fund the improvements during their construction, holding the property for you and paying for everything with the proceeds from the exchange. 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. First, the 180-day requirement in order to complete a 1031 exchange does not allow sufficient time for an elaborate Build to Suit. And existing structure can hopefully be updated and rehabbed within this time.
2nd, any updates made to the replacement property must be considered, “real-estate” to actually be part 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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