Construction/Improvement exchanges occur when the taxpayer wishes to make improvements to the replacement property utilizing the sale proceeds of the relinquished property. This usually transpires when the fair market value of the replacement property is less than that of the relinquished property. If the taxpayer were to acquire the replacement property and construct the improvements, the improvements would not qualify as like-kind property. Therefore, the taxpayer cannot take title to the replacement property until the improvements are completed. Typically, the Qualified Intermediary (QI) (or an affiliate of the QI) will take title, sign the contract with the builder and have the improvements completed. Once the improvements are completed, the intermediary conveys title to the Taxpayer.
The improvements must be identified within the 45-Day Identification Period and title of the improved property must be passed to the Taxpayer within the 180-Day Exchange Period. When dealing with real estate, it is not necessary for the improvements to be 100% complete prior to title being acquired by the Taxpayer. If the value of the improved property has been increased to an amount equal or greater than the value of the relinquished property, title may be conveyed to the taxpayer. However, the conveyed property must be substantially the same property that was identified.
Construction exchanges do require more planning than a typical delayed exchange but are an excellent solution for taxpayers who intend to make improvements. To maximize the 180-Day Exchange Period, arrangements should be made so the QI can take title to the property soon after the relinquished property is conveyed to a buyer. All permits should be secured, the contract with the builder signed and financing in place so construction can begin immediately.
There are additional expenses, including fees to the QI, an attorney and transactional expenses to the closing agent. There may also be duplicate title insurance premiums, loan costs and transfer taxes.