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.

The 200% Rule Should Be Noted As An Applicable Rule Of Identification…

It is recommended that you get a replacement property selected and a purchase agreement prepared before initiating the 1031 process. This is because “The three-property rule” (according 1031 tax exchange regulations) declares that an exchanger of a relinquished or replacement property can identify up to three properties, regardless of their value.

However, the replacement property must be received and closed on within forty-five days to avoid having to pay their capital gains taxes. If the replacement property isn’t received and closed on within the 45-day period, the investor must clearly and unambiguously, on paper, claim and identify the replacement property that is intended to be acquired.

On the other hand, if the property is closed on and received prior to the forty-five day period, the property is considered “identified”, just by receiving of property. If however the buyer intends to exceed the three property limit, the 200% Rule should be noted as an applicable Rule of identification.

Under the Two-Hundred-Percent Rule, the exchanger may identify more than 3 replacement properties, as long as their combined fair market value is not more than two hundred percent of value of the relinquished property.

What’s more, is that the purchaser may be, uncertain of the number of properties that are inclusive in the purchase often times because, a single property can be comprised of more than one plot of land. To identify whether or not the properties are considered a single unit, the presumption should be weighed by the suggestion that these properties are on the same land, listed under the same deed, are being sold by the same owner and are being financed by the same lender.

If these consequences are found to be true, then the multi-parceled property is deemed a single-unit of property. However, if, the property isn’t on the same land or under the same deed, the replacement property will be considered as separate properties.

Simply put, there must be a common, collective use among the properties in order for the properties to be considered a single unit. If someone is unsure if the replacement properties are considered a single unit, they should consult a qualified intermediary to insure compliance with either the 3 Property Rule or the Two-Hundred-Percent Rule.