Video – Building 1031 Exchange Improvements on Land You Already Own

Let’s talk about some sophisticated 1031 exchange arrangements.

One such arrangement is when people want to build improvements on land that they already own.

Let’s say you’re selling a single family home in Faribault, MN but you already own a single vacant lot in Edina, MN. You’d like to take the proceeds from the sale of your Faribault property and construct improvements on land that you already own in Edina. Is that considered a 1031 exchange?

For decades, the IRS took the position that building improvements on land you already own was not an exchange. However, there have been a few favorable Private Letter Rulings in which the intermediary doesn’t construct improvements on the fee title that’s already owned by the taxpayer. Instead, the intermediary constructs the improvements upon a new ground lease. Let’s say the intermediary’s LLC enters into a 99 year ground lease with the fee owner and the intermediary constructs the improvements on top of this new estate that didn’t previously exist. This is a very sophisticated type of 1031 exchange that should only be done with the help of a skilled intermediary.

Find a Qualified Intermediary for Your Next 1031 Exchange

Contact CPEC1031, LLC to find a qualified intermediary for your next 1031 exchange of real estate. Our 1031 exchange professionals have been working on like-kind exchanges throughout the United States for more than two decades. We can put our combined knowledge to work on your next 1031 exchange and make sure you have the greatest possible chance of deferring 100% of your capital gains taxes. Contact us at our Twin Cities office to learn more about the full extent of our services and see how we can help you through the details of your next exchange!

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2025 Copyright Jeffrey R. Peterson All Rights Reserved

Can I Get Pre-Closing Repair Costs Reimbursed in a 1031 Exchange?

If you are preparing to sell an investment property via 1031 exchange and have spent money on repairs prior to closing, you may be wondering: Can I get reimbursed for those costs using 1031 exchange proceeds?

The short answer is, “not directly.” But there are a few strategic options that may allow you to recover those costs without jeopardizing your like-kind exchange.

Why Pre-Closing Repairs Don’t Typically Qualify

In a 1031 exchange, certain transactional costs can be paid from exchange proceeds without creating a taxable event. Pre-closing repair costs are not generally considered allowable exchange expenses under Treasury Regulation §1.1031(k)-1(g)(7). However, if the repairs are made pursuant to a buyer-negotiated concession that is documented in the purchase agreement and reflected on the settlement statement, they may be treated as a seller obligation rather than personal reimbursement.

This distinction matters because expenses that fall outside the allowable category could trigger “boot,” or taxable income, which diminishes the tax-deferral benefit of the exchange.

Option 1: Accept Some Taxable Boot

One approach is to allow some boot at closing to reimburse yourself for those pre-closing repairs. While that portion would be taxable, it may not significantly impact your overall tax situation. In many cases, these repair costs are tax deductible in the year they were incurred, which could offset the tax liability, potentially making it a “wash.”

Before going this route, consult with your CPA or tax advisor to confirm whether this partial approach aligns with your broader tax picture and the nature of the expenses.

Option 2: Do a Full Exchange and Refinance Later

If your goal is to complete a 100% tax-deferred exchange, another option is to delay reimbursement. Instead, you could complete your exchange in full, then later refinance the replacement property through a separate loan transaction. This allows you to pull out equity and repay yourself for the earlier expenses without affecting the integrity of the exchange.

What Costs Can Be Paid from 1031 Exchange Proceeds?

Under Treasury Regulation §1.1031(k)-1(g)(7), several transactional expenses are recognized as safe to pay using 1031 exchange funds. Typically, these are typically costs that:

• Are customary in local real estate closings,

• Appear on the settlement statement, and

• Relate directly to the sale of the relinquished property or the purchase of the replacement property.

Examples include:

• Broker commissions

• 1031 exchange intermediary fees

• Title insurance premiums

• Escrow and closing fees

• Appraisal fees (if required by contract)

• Transfer taxes

• Recording fees

• Professional fees (CPA, attorney, or financial advisor) directly tied to the sale or purchase

These costs are supported not only by Treasury regulations but also by long-standing IRS guidance, including Revenue Ruling 72-456 and IRS Private Letter Ruling 8328011.

Connect with a 1031 Exchange Qualified Intermediary

Pre-closing repairs that are not made pursuant to a contractual requirement negotiated as a concession with the buyer, don’t fit neatly into the list of exchange-approved expenses. However, with smart planning, whether accepting some taxable boot or structuring a post-exchange refinance, it may still be possible to recoup those costs without completely undermining the benefits of your 1031 exchange.

As always, the key is consulting with a tax professional who understands the nuances of 1031 exchange rules and can guide you toward the most advantageous strategy for your situation.

Thinking about a 1031 exchange? Feel free to call me, Jeff Peterson, at 612-643-1031, or email me at jeffp@CPEC1031.com.

Defer the tax. Maximize your gain.

© 2025 Copyright Jeffrey R. Peterson All Rights Reserved

Video – Understanding 1014 Tax Code

Under section 1014 of the Internal Revenue Code, when you inherit property from someone upon their death, you don’t take the low basis that they carried with them throughout their lifetime. Instead, your basis is stepped up to the fair market value of the property at the time of the decedent’s death. When the decedent dies there is probably a property valuation conducted for estate tax purposes. Whatever that value is, that’s likely the value you receive as your basis going forward. That’s a really good deal if you inherit property because you can potentially sell it the day after the funeral and not have any gain because your basis has been stepped up.

Twin Cities 1031 Exchange Services

CPEC1031, LLC offers 1031 exchange services to the Twin Cities area, as well as greater Minnesota and the entire United States. We provide qualified intermediary services to taxpayers conducting forward exchanges, reverse exchanges, construction exchanges, and more. No matter what type of exchange you are interested in, we have the skills and experience to guide you through the exchange process. Contact us to talk about the specifics of your next 1031 exchange and see how we can help you defer taxes on the sale of qualifying real estate.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2025 Copyright Jeffrey R. Peterson All Rights Reserved

What Happens If My 1031 Exchange Partially Fails?

Understanding Tax Implications When a 1031 Exchange Doesn't Go as Planned

A 1031 exchange is a powerful tool for deferring capital gains taxes on the sale of investment real property. But what happens if the like-kind exchange doesn’t fully succeed? Maybe you could not identify a replacement property in time, or you chose not to reinvest the entire sale proceeds. Does that mean you are automatically hit with a huge tax bill?

Not necessarily, but partial exchanges do trigger tax consequences that should be understood ahead of time.

Understanding Boot and Partial 1031 Exchanges

When a taxpayer conducting a 1031 exchange receives cash or non-like-kind property as part of an exchange, that portion is known as "boot" and it is taxable to the extent of the realized gain.

It’s a common misconception that you can receive your “original basis back” tax-free. In actuality, the IRS taxes gain before basis is recovered when boot is received. So, if your relinquished property sells for $500,000 and you have $300,000 of basis, any boot received is first applied against your gain, not your basis. “Boot” triggers recognition of gain, and that gain is taxed before any remaining basis is returned to the taxpayer. Why does this happen? In a 1031 exchange, your old basis transfers to the replacement property. The IRS does not allow you to recover basis tax-free ahead of recognizing gain when boot is involved.

What Taxes Might Apply?

When a 1031 exchange is only partially completed, or if it involves boot, here are the types of taxes you may be subject to:

• §1245 Recapture: Up to 39.6%
  Applies to depreciation on personal property or components of certain mixed-use assets.

• §1250 Depreciation Recapture: Up to 25%
  Depreciation taken on real property is subject to recapture if gain is recognized by the taxpayer.

• Federal Capital Gains Tax: Up to 20%
  Applies to any appreciation not offset by basis or depreciation.

• §1411 Net Investment Income Tax: 3.8%
  This surtax applies to high-income taxpayers over a certain threshold with passive real estate income or gain.

• State and Local Taxes: Varies
  Several states and many municipalities impose their own capital gains or income taxes on real estate transactions.

Planning Is Key

Partial exchanges occur for many reasons: tight market conditions, failed inspections, financing limitations, or timing challenges. But with proper planning, the tax impact of receiving boot can be anticipated, calculated, and in some cases, mitigated.

For example:

• You may choose to receive boot in the form of a mortgage payoff or cash back at closing with full awareness of the tax it triggers.

• Alternatively, you might decide to complete a full exchange, then consider a refinance after closing in a separate transaction to access liquidity in a more tax-efficient manner.

Partial 1031 Exchanges Still Offer Beneficial Tax Deferral

A “less than perfect” 1031 exchange doesn’t eliminate all the benefits of tax deferral. Even partial deferral can improve your financial position, but you must understand how the IRS applies gain recognition when boot is involved. Remember: gain is taxed before basis is returned.

If you are considering a 1031 exchange and wondering about partial reinvestment, depreciation recapture, or the impact of boot, now is the time to consult a qualified tax advisor.

• Thinking about a 1031 exchange? Feel free to call me, Jeff Peterson, at 612-643-1031, or email me at jeffp@CPEC1031.com.

Defer the tax. Maximize your gain.

© 2025 Copyright Jeffrey R. Peterson All Rights Reserved

Replacement Property Pitfalls in a 1031 Exchange: What You Need to Know

When it comes to executing a successful 1031 exchange, many investors focus on the property they’re selling. However, the real complexity often lies on the other end of the transaction: the replacement property.

Identifying and acquiring the right replacement property is essential to preserving the tax-deferred status of your 1031 exchange. There are several nuanced issues that can cause delays, trigger taxes, or even disqualify your like-kind exchange altogether.

Here are five key considerations to help you navigate potential replacement property challenges with confidence.

Start the Search for Replacement Property Early. In Some Cases, Really Early.

One of the biggest mistakes taxpayers make during the 1031 exchange process is waiting too long to begin looking for replacement property. Under IRS rules, you have just 45 calendar days from the closing of your relinquished property to identify potential replacements and 180 days to close.

In a tight or competitive real estate market, this window can close fast. Savvy investors often begin scouting for replacement property well before closing on the relinquished property. In some cases, it may even make sense to acquire the replacement property first through a reverse exchange, which requires careful structuring and experienced qualified intermediaries.

Confirm It’s Like-Kind Property

To qualify for tax deferral, the replacement property must be like-kind when compared to the relinquished property. In the context of real estate, “like-kind” is interpreted broadly. For example, you can exchange a retail building for farmland, or a warehouse for an apartment complex.

However, issues can arise when:

• Personal property (e.g., equipment, furnishings, or other personal property) is involved

• The property is a personal use property (e.g., a vacation home or a second home)

These scenarios may disqualify the transaction. Be sure the replacement property is held primarily for investment or business use, as opposed to personal use.

Hoping to Make Improvements? Plan Accordingly.

Some investors see an opportunity to upgrade or build on their replacement property as part of an exchange. That can work but only if it is structured properly as an improvement exchange.

Improvement exchanges require the qualified intermediary (or an exchange accommodation titleholder) to hold title during construction, and any improvements must be completed (or at least built into the property’s value) within the 180-day exchange window. These are complex transactions that require advanced planning and coordination with all parties involved.

Be Cautious with Related Parties

Buying replacement property from a related party can be a red flag for the IRS. Even if the property is like-kind and all other requirements are met, the IRS may challenge the transaction if it believes the exchange was structured to inappropriately avoid taxes.

If a related-party transaction is planned, you should consult your tax advisor early. There are strict limitations and documentation requirements and in some cases, alternative options may be safer.

Co-Ownership? Understand the Structure First

Co-owning replacement property, whether with a spouse, business partner, or investment group, can be done, but it needs to be structured correctly. The IRS is concerned about who the taxpayer is, so the entity that sells must be the same entity that buys.

Common co-ownership structures include:

• Tenants-in-common (TIC) arrangements

• Delaware Statutory Trusts (DSTs)

• Properly structured partnerships

Each has different implications for control, liability, and IRS compliance.

Assemble an Experienced 1031 Exchange Team

The replacement property is not just the second half of your 1031 exchange, it is where many of the risks and opportunities reside. From timeline pressures to title structure, due diligence concerns, and related-party rules, what you do next can determine whether your exchange stays on track or runs into trouble.

The best way to navigate these complexities? Start early, stay informed, and rely on a team of experienced professionals including your qualified intermediary, CPA, attorney, and real estate advisor.

• Thinking about a 1031 exchange? Feel free to call me, Jeff Peterson, at 612-643-1031, or email me at jeffp@CPEC1031.com.

Defer the tax. Maximize your gain.

© 2025 Copyright Jeffrey R. Peterson All Rights Reserved