1031 To Your Dream Property
An essential fact in regard to 1031 exchanges is that you may not make use of the proceeds of the original sale to construct property you own. This is a frequent pitfall of unwary real estate investors. In order to qualify for a capital gains tax deferral, your replacement property has to be of LIKE KIND with the property it is replacing. Thusly, the property you acquire as a result of the 1031 exchange has to constitute real estate with a value greater than or equal to that of the property sold. An improvement that is incomplete is considered a contract for a service, which constitutes personal property but not real estate. Due to the fact that a property acquired in a 1031 exchange has to be of like kind and equivalent value with the property sold upon closing, it can be hard to find a property that complies with these legal requirements but also 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 acquire a build-to-suit property that fits your wants and needs as well as fulfilling the accounting requirements necessary for a like-kind exchange.
The first option is to conduct what is known as a poor man’s build to suit in which you, as the purchaser, request that the seller make certain renovations on a piece of property to increase its value prior to closing on the sale. For example, if you were to sell a a piece of property with a value of $100,000, and you were considering a replacement property worth at $10,000, the seller of the property could construct ninety thousand dollars’ worth of improvements to raise the value of the real estate. The finished renovations would constitute real estate, and you would then be able to the property for one hundred thousand dollars, fulfilling the requirement that the two properties be of equivalent value. the majority of sellers, however, will not be very enthusiastic to perform these improvements so that you can make a 1031 exchange.
In the 2nd, more likely scenario a qualified intermediary who is holding your funds can buy the replacement property from the seller and take title to it in a limited liability company, intermediary-owned company. The intermediary would then use the remaining proceeds to construct the necessary renovations on the piece of property. Upon completion, the intermediary returns the property to you, which then permits you to complete the exchange .
Returning to the previously mentioned $10,000 replacement property: the intermediary who was holding your funds would buy the aforementioned piece of real estate at the asking price and would make the necessary renovations with the remainder of the funds, returning the replacement property to you when the value of the property is high enough to establish likeness with the relinquished property.
Although a Build-to-Suit exchange can help you acquire the replacement property that is right for you, it is key to consider the amount of time required for the improvements that you would like to construct on your property. You have only 180 days in which to bring your 1031 exchange to completion, so it is important to be conscious of what work can actually be finished in this time span. Be mindful that a renovation represents real estate when it is completed, and so work in the process of construction doesn’t add to the property’s value. Though you may not be able to modify your property as extensively as you might want, one hundred and eighty days is plenty of time to complete considerable improvements, and to bring your replacement property that much closer to the property of your dreams.
