This Tuesday’s Tip is for everyone who asks if you can use exchange proceeds to make improvements to your replacement property.
An improvement exchange allows you to use some of the 1031 exchange proceeds to make improvements to the replacement property. This type of exchange is usually structured when the purchase price of the replacement property is less than the net selling price of the relinquished property. It’s not as simple as you buying the replacement property and then making the improvements because the improvements would not qualify as like-kind property. The value of the property at the time you acquire it is all that can be counted. Title to the replacement property can be conveyed once the desired improvements are constructed. 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 desired improvements are constructed, the SPE conveys title to you at the higher price to complete your 1031 exchange.
The improvements must be identified within the 45-Day Exchange Period and title to the improved property must be conveyed from the QI to you within the 180-Day Exchange Period. For real property 1031 exchange purposes, it is not necessary for the improvements to be 100% complete before title is passed to you. However, to maximize your tax-deferral, the value of the improved property at the time of the transfer should be equal or greater than the net selling price of the relinquished property. To satisfy the identification requirements, the improved property must be substantially the same property that was identified within the 45-Day Identification Period.
Improvement exchanges do require more planning than a typical delayed exchange but are an excellent solution for those who want to make improvements. To maximize the 180-Day Exchange Period, every effort should be made so the QI can take title to the property soon after the relinquished property is conveyed to a buyer. The plans should be finalized, permits secured, contract with the builder signed and financing in place so construction can begin immediately.
Note 1031 CORP. creates a limited liability company (LLC) to hold title to the property. 1031 CORP. creates a new LLC for each property we take title to and either assigns the LLC to our client or dissolves the LLC at the end of the exchange.
There are additional expenses, including fees to the QI and an attorney as well as transactional expenses to the closing agent. There may also be duplicate title insurance premiums, loan costs and transfer taxes. It is important to discuss your situation with your tax advisor to make sure the benefits of the transaction are not lost due to the costs of an improvement exchange.
The Exchange Team at 1031 CORP. is always happy to discuss your situation. Contact us now.
