A 1031 improvement exchange is an exchange where you’re selling a piece of relinquished property at a large value (say a million dollars), and you want to acquire new replacement property but the initial land cost of your replacement property is less than the relinquished property value (say $500K). That’s not enough replacement property to defer all of your gains in a 1031 exchange. But you’re planning on constructing $500K worth of like-kind improvements on top of that new acquisition. How do we construct an exchange with these factors?
There’s a case called Bloomington Coca-Cola that stands for the proposition that once the taxpayer acquires their new land, the exchange is over and any improvements that you construct won’t count towards your 1031 exchange.
Thankfully, there is a way around this issue. You need to have the improvements constructed and exist as like-kind property before you receive them. Often people will engage in a build-to-suit exchange, wherein their Qualified Intermediary forms an LLC to acquire the raw land and the LLC owns that land while the $500K of improvements are constructed. Then once the like-kind property exists and is valued at least as much as the relinquished property, the replacement property can be transferred to the taxpayer.
But guess what? You don’t have a lot of time for construction (only 180 days) so you’re not going to be able to construct the Taj Mahal. You’re only going to have time to make modest improvements and repairs during the exchange period. A partially completed Replacement Property can still count for your 1031 exchange, so long as there is enough existing like-kind real property improvements existing and completed by the 180th day of your exchange period.
- 1031 Hotline: If you have questions about 1031 improvement exchanges and build-to-suit exchange, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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