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The Improvement Exchange Improvement (build-to-suit or construction) exchanges allow an investor to use exchange proceeds to either (1) make improvements to an existing property or (2) build a new replacement property. This variation is extremely popular because it provides the opportunity to purchase properties needing renovation or to acquire bare land and build to an investor's exact specifications. The Qualified Intermediary makes improvements to the replacement property during the exchange period and transfers the improved property back to the Exchanger by the 180th day. Advance planning is essential; normal construction delays, inclement weather and obtaining government permits can make it a challenge to complete the needed improvements within the 180-day exchange period.
THE IMPROVEMENT EXCHANGE
What is It?
An Improvement Exchange allows an investor to acquire precisely what is desired. The improvement procedure allows the construction of the “perfect” replacement property.
Why Use It?
As with any exchange the basic like-kind concept must be applied. When the Exchangor gives up real property, we must give the Exchangor real property back. If the Exchangor were to receive unimproved land with labor and materials to be used in the future, the exchange would not be totally tax-deferred. The labor and materials unused are “boot” and could therefore trigger tax. A common misbelief is that escrow holdbacks will satisfy exchange requirements, this strategy could fail under audit.
Improvement Exchange Options
Any exchange involving improvements must be carefully planned. The Exchangor has three basic strategies for success:
Often the easiest and least expensive solution to the improvement puzzle is to ask the current owner to perform the improvements. The cost of the improvements is usually built into the purchase price for the property. This strategy allows the completion of a basic simultaneous or delayed exchange. The downside is primarily that the seller just wants to sell the property and may not participate. The seller may be unwilling because his or her basis and sales price will also rise, this may or may not be a problem.
Another option is to have a developer or other entity obtain and develop the desired property. This strategy can yield a “basic” exchange yet often gets very complicated. Usually funding the project is a primary concern, contracts must be drawn to provide the Exchangor the necessary assurance for completion. Often exchange proceeds are requested for completion of the project, if this occurs the facilitator must be on the construction contracts.
The final choice is usually that of the facilitator personally or through alternate entity taking ownership to the replacement property then completing the necessary improvements. Often this strategy is less complicated than number two above. This technique is usually the most costly in exchange fees, but often results in a more defensible exchange.
What About Improving My Current Property?
We often receive inquiries regarding the use of exchange proceeds for improvements to another property owned by our Exchangor, can this be done? Generally, the experts agree this is not a good idea though several “liberal” letter rulings state the contrary.
Consult Tax and Legal Counsel
Equity Advantage will gladly evaluate your objectives to give you the appropriate options. Any exchange should be well planned, Reverse Exchanges demand it. Competent tax and legal counsel is critical to the success of this exchange technique.
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