Investors – What the Heck is a Build to Suit Exchange?
You may have heard of the money saving capability of a 1031 tax exchange – and how it allows you to defer all of the capital gains taxes on the sale of your investment property, buy moving them into another investment property that is similar in kind. 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.
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 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. 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 $10 thousand dollars, which will obviously not completely qualify for a like-kind exchange and thus, no deferred tax gain.
In this case, the property investor would request that the seller raise the price of the property $100,000 – but before closing – construct $90,000 worth of improvements to the investment property. After all is said and done, she’ll purchase a replacement property or the same value, which is $100,000.
Finding a replacement property seller who is willing to increase the sales price, and make improvements before closing, may be difficult. One other approach to this is to have the QI (or qualified intermediary) purchase the replacement property for $10,000 – 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. 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. However, it should be enough time to rehabilitate or remodel an existing structure.
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. Merely dumping materials on the property will not suffice; the materials must be constructed or affixed into the land and be made a permanent part of the structure to constitute real estate.
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.
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