Two Ways Get The Build-To-Suit 1031-Property You Want
By: Trisha Coppley
A key truth in regard to 1031 exchanges is that you CANNOT use the proceeds of the original sale to construct land you already own. This is a frequent pitfall for unwary real estate investors. In order to qualify for a capital gains tax deferral, the replacement property must be of LIKE KIND with the relinquished property. Thusly, the property you purchase has to constitute real estate with a value at least as high, if not greater than that of the relinquished property. A renovation that is incomplete is considered a contract for a service, comprising personal estate but not real property. Due to the regulation that a property purchased as a replacement in a 1031 exchange has to be equivalent in type and value with the relinquished property upon closing, it is, at times, difficult to find a property that fulfills these legal requirements and fulfills his or her specifications.
So, is there a way to what you really want out of a exchange? There are two main methods by which you can go about acquiring a custom-built property that fits your structural specifications and fulfills the accounting requirements necessary for a like-kind exchange.
Your first option is to conduct a poor man's build to suit in which you, as the purchaser, request that the seller construct particular renovations on a property in order to increase its value prior to closing . To illustrate: if you sold a a piece of property worth $100,000, and you were considering a replacement property valued at $10,000, the seller of the property could make ninety thousand dollars' worth of improvements in order to raise the property value. The finished renovations would constitute real estate. You would then be able to the property for one hundred thousand dollars, complying with the requirement of equivalent value. Most sellers, however, will not be very enthusiastic to construct these renovations so that you may conduct an exchange. This brings us to the second option.
In the second, more likely scenario an intermediary who is holding the proceeds from the sale of the relinquished property buys the replacement property from the seller, taking title to the property in a limited liability company, intermediary-owned company. The intermediary would then use what remains of the proceeds to construct the necessary renovations on the property. Upon completion, the intermediary returns the replacement property to you, allowing you to complete the exchange .
Back to the ten thousand dollar replacement property: the intermediary who was holding your funds would buy it for the asking price and would make the required renovations using what is left of your money, returning the replacement property to you when the property's value is high enough to establish likeness with the relinquished property.
Although a build to suit exchange can go a long towards getting you the replacement property that you really want, it is essential to take into consideration the time required for the construction of necessary improvements. You have only 180 days to complete an exchange, so you must be conscious of what work can actually be brought to completion in this time span. Be mindful that an improvement is only considered real estate when it is finished, so a work in the process of construction doesn't increase the value of the property. Although you may not be able to modify your replacement property as extensively as you might want, one hundred and eighty days is enough time to finish considerable remodeling, and to bring your replacement property that much closer to the property of your dreams.
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