Overview of the Improvement 1031 Exchange
This article will provide you with a very brief and concise overview of Improvement 1031 Exchange transactions. These 1031 Exchange structures are also referred to as Build-To-Suit 1031 Exchanges or Construction 1031 Exchanges. These names all refer to the same 1031 Exchange strategy that allow you to not only use your 1031 Exchange proceeds to buy replacement property but to also use some of your 1031 Exchange funds to improve your acquired replacement property.
Improvement 1031 Exchange transactions are complex tax-deferred strategies. You should always seek the advice of your legal, financial and tax counsel before entering into any Improvement Exchange transaction. Exeter 1031 Exchange Services, LLC is always available to work with you and your advisors in planning your Improvement 1031 Exchange.
Improvement 1031 Exchanges
The Improvement Exchange allows you to structure a 1031 Exchange transaction where you can sell your relinquished property and use the proceeds from the sale of your relinquished property to acquire replacement property. It also allows you to use some of your sale proceeds to improve the acquired replacement property as part of your 1031 Exchange transaction.
The proceeds from the sale of your relinquished property that are used toward the acquisition of your replacement property as well as those proceeds that are paid or used for improvements to your replacement property will qualify for tax deferred exchange treatment provided the transaction is structured properly as an Improvement Exchange.
Improvement 1031 Exchanges are combined or used in conjunction with either a Forward Exchange or a Reverse Exchange structure. These are significantly more complicated 1031 Exchange transactions and should only be administered by a Qualified Intermediary that has significant experience and expertise with Improvement Exchanges.
Improvement Exchange With a Forward 1031 Exchange
Forward 1031 Exchange transactions can be structured to take advantage of the Improvement 1031 Exchange strategy. This combined 1031 Exchange strategy allows you to sell your relinquished property first and then subsequently identify and acquire replacement property as well as make improvements to your replacement property as part of your 1031 Exchange transaction.
The identification of the replacement property and the improvements to be made to the acquired replacement property, as well as the actual closing on the replacement property, must be performed and completed within the prescribed 1031 Exchange deadlines.
Improvement Exchange With a Reverse 1031 Exchange
Reverse 1031 Exchange transactions can also be structured to take advantage of the Improvement 1031 Exchange strategy. This combined Reverse and Improvement 1031 Exchange strategy allows you to acquire your replacement property first and also improve the acquired replacement property during the time that you're trying to sell your existing relinquished property.
The improvements that are to be made to the acquired replacement property, as well as the actual transfer of the replacement property with the completed improvements to you from the Exchange Accommodation Titleholder (see comments below), must be performed and completed in conjunction with the closing of the sale of your relinquished property within the prescribed 1031 Exchange deadlines.
No matter which combined strategy you choose, the Improvement 1031 Exchange allows you to acquire your replacement property and use some of your 1031 Exchange funds to improve your acquired replacement property on a tax-deferred basis provided the proper parking structure has been put into place.
Parking Arrangement Pursuant to Revenue Procedure 2000-37
The replacement property can not be acquired and held directly by you while the improvements or renovations to the property are being completed. Legal title to your replacement property must be acquired and held or "parked" by an Exchange Accommodation Titleholder (Exeter Reverse 1031 Exchange Services, LLC) in order to properly structure an Improvement 1031 Exchange transaction and qualify for tax-deferred exchange treatment.
This "parking arrangement" is outlined and permitted pursuant to Revenue Procedure 2000-37. The Internal Revenue Service issued Rev. Proc. 2000-37 on September 15, 2000, which provides guidance on how to properly structure an Improvement 1031 Exchange transaction by using a parking arrangement in conjunction with either a Forward 1031 Exchange or a Reverse 1031 Exchange.
The Parking Arrangement
You will enter into an agreement called the Qualified Exchange Accommodation Agreement or "QEAA" that will define and structure the parking arrangement to be used for your Improvement Exchange transaction. The QEAA is entered into by and between you and Exeter Reverse 1031 Exchange Services, LLC as your Exchange Accommodation Titleholder or "EAT".
The Exchange Accommodation Titleholder or "EAT" is (and always should be) a separate legal entity apart from the Qualified Intermediary. The EAT will purchase and hold or "park" legal title to your replacement property during your Improvement 1031 Exchange transaction through a special purpose entity often referred to as an "SPE."
Special Purpose Entity
Exeter Reverse 1031 Exchange Services, LLC, which serves as your Exchange Accommodation Titleholder or "EAT", will set-up a special purpose entity or "SPE" in the form of a single member limited liability company or SMLLC that will be used exclusively to acquire and hold or "park" title to your replacement property during your Improvement 1031 Exchange.
The formation of this special purpose entity is crucial in order to protect you and your replacement property from liens, judgments and other legal problems stemming from other clients' parked properties. The SPE ensures that your parked property will never be held in an entity that also holds other clients' parked properties.
Improvement 1031 Exchange Deadlines
Deadlines to complete your Improvement Exchange are the same as a Forward 1031 Exchange or a Reverse 1031 Exchange transaction, depending on which structure you have chosen to combine with your Improvement Exchange.
The 45 and 180 calendar day deadlines are the same. You have 45 calendar days to identify the appropriate property, again depending on which structure you have chosen, and you have an additional 135 calendar days — for a total of 180 calendar days — to complete your Improvement 1031 Exchange transaction.
Improvement Exchange Fees and Costs
Improvement 1031 Exchanges are more complicated and costly structures, so you need to review the amount of depreciation recapture and capital gain income tax liabilities being deferred to ensure that the cost of the Improvement 1031 Exchange transaction is justified.
Exeter 1031 Exchange Services, LLC would be happy to provide you with a written fee quote so that you know exactly what your Improvement 1031 Exchange fees and costs will be prior to getting started with your transaction.
This article has been a very quick, basic and concise overview of Improvement 1031 Exchange transactions. You can click here for more information on how you can get started if you are ready to proceed with an Improvement Exchange contact one of our 1031 Exchange Advisors for assistance.
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