A key truth about 1031 exchanges is that you cannot make use of your 1031 proceeds to make improvements on land you own already. This is a common pitfall of inexperienced real estate investors. In order to qualify for deferment of capital gains taxes, your replacement property has to be of like kind with the relinquished property. In this case, the replacement property has to comprise real estate with a value greater than or equal to that of the property sold.
A renovation that is not completed is considered a contract for a service, which constitutes personal estate but not real property. Due to the regulation that a property purchased as a replacement in a 1031 exchange must be equivalent in type and value with the property sold at the time of closing, it can be difficult to find one that fulfills these requirements but also fulfills his or her specifications. So, is there a way to the property of your dreams out of a exchange? There are two main methods by which you can acquire a custom-built 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 perform what is known as a 'poor man's Build-to-Suit,' in which you, as the purchaser, ask the seller to construct certain renovations on a property to increase its value prior to closing .
To illustrate: if you relinquished a a piece of property worth one hundred thousand dollars, and were looking at a replacement property worth at $10,000, the seller could construct $90,000 worth of improvements to raise the value of the property. The completed improvements would constitute real estate. You would then be able to the property for $100,000, fulfilling the requirement of equivalent value.
the majority of sellers, however, will not be very eager to perform these improvements so that you can make an exchange. This brings us to the second option. In the other, more likely scenario a qualified intermediary who is holding the proceeds from the sale of the relinquished property purchases the replacement property from the seller and take title to it in a limited liability company owned by the intermediary.
Then, the intermediary would make use of the remainder of the proceeds to make the necessary improvements on the property. After construction is done, the intermediary transfers the property to you, which then allows you to complete the exchange . Returning to the ten thousand dollar replacement property: the intermediary who was holding your money would buy it for the asking price and would construct the desired renovations using what is left of your funds, transferring the property to you when the value of the property is sufficient to constitute a like kind exchange.
Although a build to suit exchange can help you acquire the property that you really want, it is essential to take into consideration the time required for the construction of necessary improvements. You have only one hundred and eighty to complete an exchange, so you need to be conscious of what work can actually be brought to completion in this time span. Keep in mind that an improvement is only considered to be real estate when it is finished, and so renovation in the process of construction doesn't add to the property's value.
Although you might not be able to construct improvements as extensive as you might want, one hundred and eighty days is plenty of time to complete considerable remodeling and renovation, and to bring your replacement property much closer to your ideal.
Many Investment Properties Qualify For A 1031 Property Exchange. Be Sure To Consult With A 1031 Exchange Intermediary To Maximize Your Tax Savings. More Information Is Available At http://www.Top1031Exchange.com