I read this and felt it was important enough to share. So with permission, 1031 Exchanges with improvements. Good advice for savvy real estate investors. In complex real estate transactions it’s what you don’t know that can hurt you. Assemble a team of experts, get the advice you need.
With a very limited inventory of available properties the good ones are quickly snapped up. Properties that languish on the market do so for a reason – many of them have significant deferred maintenance. These properties generate a lot of calls to our office. The primary question…
Can exchange funds be used to make the necessary improvements?
Yes, with the following requirements:
1. The improvements must be identified, and
2. The work must be performed before the Exchanger becomes the owner.
If the Exchanger can’t be the owner, who will be?
There are several options:
Option 1 – Seller Owns and Improves
The Exchanger negotiates with the Seller to have the Seller make the improvements and increase the sales price. (Sellers seldom agree to do this.)
Option 2 – Seller Owns and Exchanger Improves
The Exchanger negotiates with the Seller to allow Exchanger’s contactor on the property prior to closing to make the improvements. The closing occurs after the work is completed. This is most often utilized when the project is of short duration, for example, installation of a new furnace. (The risk to both Seller and Buyer would cause most attorneys to blanch at the thought.)
Option 3 – EAT Owns and Improves
Utilizing Revenue Procedure 2000-37 the property can be “parked” with an Exchange Accommodation Titleholder (EAT), a service provided by the exchange company. The work takes place while the EAT owns the property. This revenue procedure permits the Exchanger to fully manage and control the property and project.
There will be additional expenses associated with the parking arrangement – extra closing costs, tax advisor expense, lender fees, EAT fees, etc. When all these expenses are tallied the cost can be $10k, or more. Utilizing the EAT can make financial sense when the improvements are $100k, or more.
What does not work?
A holdback in escrow or prepayment of vendors and contractors does not work. With either of these arrangements the work will be performed after the Exchanger owns the property and is viewed by the IRS as the receipt of “goods and services” not like kind real estate.
What if the improvements cannot be completed within the 180-day exchange period?
As long as the improvements, when completed, are substantially similar to what was identified, the Exchanger will get credit for the value in the ground at the point the property is transferred to them.
Before proceeding with any 1031 exchange consultation with tax and legal advisors and Beutler Exchange Group is essential.