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Tax Deferred
Construction Exchanges
Exchangers sometimes need to acquire property on which they will build improvements or renovations that they wish to include as exchange replacement property. Improvements on land an exchanger has already acquired will not count as replacement property in a 1031 tax exchange. By utilizing an “Improvement or Construction Exchange” it would be possible for an exchanger to receive property that is renovated, improved to the exachanger’s specifications in a tax deferred exchange.
In an “Improvement or Construction Exchange”, proceeds from the sale of relinquished property are received and held by Bankers Escrow Corporation as provided by IRS rules. Transfer of the completed replacement property is made within 180 days after the relinquished property sale. Funds from the relinquished property are used to supplement other financing which permits both the purchase and construction of improvements on the replacement property. It is necessary that all improvements and funds be utilized within the 180 day period after the sale of the relinquished property. An improvement or construction exchange can allow an exchanger to acquire and improve property and save capital gains tax. The steps in a simple improvement exchange are:
- Exchanger sells old property and enters into an exchange agreement. An exchange fee of is charged as a selling expense on the settlement statement. The Exchanger has 45 days from the closing date of the old property to identify replacement property.
- Replacement property in need of improvements is required to be placed under contract specifying that the Buyer and/or Assigns will be purchasing the property. Before closing, Bankers Escrow sets up an Exchange Accommodating Titleholder entity to purchase the property to be improved. This Exchange Accommodating Titleholder is a Limited Liability Company (LLC). The Exchangers 1031 proceeds are utilized by the LLC to acquire the property to be improved. If there are not sufficient exchange funds for the purchase, the LLC either obtains funds from the Exchanger or together with the Exchanger obtains a commercial bank bridge loan.
- 3. The Construction Improvement Exchange Agreement is prepared and entered into by the Exchanger and the LLC. The property is acquired by the LLC. An option fee of is charged at the closing of the property. The Exchanger enters into a General Contractor Agreement with the LLC for the improvements to be constructed. The improvements must be constructed and completed within 180 days from the date that the Exchangers old property is sold. All construction draws are approved by the Exchanger and the LLC makes arrangements with Bankers Escrow Corporation for the payment from 1031 proceeds held, or coordinates the construction draw requests with the commercial bank.
- Once the improvements are complete the new improved option price of the property is determined (original acquisition cost plus improvements). The property is scheduled to close on or before the 180th day deadline. The improved property is sold from the LLC to the Exchanger as their replacement 1031 property. The exchange is complete!
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Bankers Escrow Corporation
Corporate Headquarters
44 Union Blvd. Suite 115
Lakewood, CO 80228
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