An improvement (or build to suit) exchange is used when the investor identifies replacement property requiring improvements during the exchange period. Funds from the relinquished property can be used for improvements. (Typically, improvements are made to an unimproved lot or as enhancements to an improved property to create adequate value to balance the exchange.) When planning an improvement exchange, investors should take normal construction delays, inclement weather, and the time required to obtain building permits into account to schedule completion within the 180-day exchange period.
Steps in an Improvement Exchange
- Replacement property is parked with JELD-WEN 1031, who holds the title, though the exchanger can manage construction.
- The replacement property, including intended improvements, must be identified in writing within 45 days of the relinquished property closing.
- The entire exchange transaction must be completed within the 180-day exchange period, and if improvements are not completed in that time, only the value of "like kind" property can be considered for tax deferral purposes.
Improvements to Taxpayer Owned Property
On August 16, 2004, the Internal Revenue Service issued Revenue Procedure 2004-51, 2004-33 I.R.B. to modify previously issued Revenue Procedure 2000-37, establishing new rules and procedures for reverse exchanges. Rev. Proc 2004-51 states that any replacement property owned by a taxpayer within 180 days before being transferred to an Exchange Accommodation Titleholder (EAT) as part of a reverse exchange does not qualify for tax deferral under IRC Section 1031. This modification prohibits the transfer of a property currently owned by a taxpayer to an EAT in order to perform a reverse exchange into improvements made on that property.
Revenue Procedure 2004-33 is a very strong statement by the IRS affirming its objection to exchanges of a fee interest in real estate for improvements constructed on land already owned by the taxpayer. The Revenue Procedure states, in part, "an exchange of real estate owned by a taxpayer for improvements on land owned by the same taxpayer does not meet the requirements of Section 1031."
Knowing that an exchange of this nature (whether delayed or reverse exchange) will most likely be challenged by the IRS in an audit, it is imperative that any taxpayer wishing to perform this type of exchange seek the guidance and counsel of a tax advisor.