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A 1031 exchange is an excellent tool for investors who want to prevent paying tax on the gain from the sale of property; nevertheless, in order to entirely defer the tax, an investor should discover several replacement residential or commercial properties with a total fair market value that equates to or exceeds what is being offered, and should use all the cash from the existing residential or commercial property and invest it in the brand-new residential or commercial property. Many skilled genuine estate financiers who recognize with 1031 exchanges do not understand that a build-to-suit exchange can provide them more versatility in structuring their transactions to fulfill these requirements.

The build-to-suit exchange permits an owner to use the earnings from the sale of the given up residential or commercial property not just to acquire replacement residential or commercial property, however likewise to make enhancements to the residential or commercial property. For example, if a financier offers given up residential or commercial property with a fair market price of $1 million, debt of $200,000 and equity of $800,000, he needs to get a residential or commercial property equivalent to at least $1 million and needs to invest a minimum of $800,000 into that residential or commercial property. In a build-to-suit exchange, nevertheless, the investor could get residential or commercial property worth just $300,000, obtain an additional $200,000 and spend the staying $500,000 of exchange proceeds plus the $200,000 in loan funds on improvements to the residential or commercial property. This would consume the remaining money and increase the reasonable market price of the replacement residential or commercial property to $1 million, leading to a totally tax-deferred exchange.

STRUCTURING A BUILD-TO-SUIT EXCHANGE

A build-to-suit exchange is accomplished by having a holding entity called an Exchange Accommodation Titleholder (EAT) temporarily hold title to the replacement residential or commercial property while the enhancements are being made. The EAT is generally a limited liability company owned by a Qualified Intermediary (QI). The EAT is required due to the fact that any work done to the residential or commercial property after the financier takes title to it is ruled out like kind residential or commercial property and for that reason will not increase the value of the residential or commercial property for exchange purposes.

A build-to-suit exchange can be structured either as a deferred exchange where the existing residential or commercial property is sold before the brand-new residential or commercial property is acquired, or a reverse build-to-suit, where the brand-new residential or commercial property is gotten initially. In either case, the whole transaction should be completed within 180 days.

In a delayed build-to-suit exchange, the relinquished residential or commercial property is gotten rid of and the sale continues go to the qualified intermediary. The investor needs to recognize what is to be acquired within 45 days, including a description of what will be constructed on the residential or commercial property. The EAT obtains the residential or commercial property utilizing the exchange funds. The investor oversees the construction of the enhancements and periodically sends out invoices to the EAT, who pays them using exchange funds. The replacement residential or commercial property is moved from the EAT to the investor on the earlier of when the building is complete, when the 180 days expires or when enough worth is contributed to the replacement residential or commercial property for full tax deferment.

In a reverse build-to-suit exchange, the replacement residential or commercial property is gotten by the EAT first, utilizing funds from the investor or a lender. Similar to a deferred exchange, the financier supervises the building and construction and sends billings to the EAT, but the EAT needs to borrow money from the lender or the financier to pay the billings. At some time during the 180 day duration, the given up residential or commercial property is sold and funds are moved to the QI. If there is more building needed, the exchange funds can be used for the building and construction until the 180 day period expires. As with the postponed build-to-suit, the replacement residential or commercial property is transferred from the EAT to the investor on the faster of when the building and construction is total, when the 180 days expires or when adequate worth is included to the replacement residential or commercial property for complete tax-deferral.

BENEFITS AND DRAWBACKS OF DOING A BUILD-TO-SUIT EXCHANGE

The advantages of doing a build-to-suit exchange include the capability to purchase residential or commercial property that is lower in worth compared to the relinquished residential or commercial property and the capability to utilize exchange funds instead of loan profits to money building.

The principal downside of doing a build-to-suit exchange is that the work must be done within the 180 day period in order to have any impact on the exchange. For a lot of big building and construction tasks, this is tough; however, smaller sized projects or improvements to existing structures can frequently be accomplished within the required amount of time. In addition, build-to-suit exchanges are more costly than routine deferred exchanges, due to the fact that the EAT will take title to the replacement residential or commercial property, which results in an extra realty transfer. Escrow fees, closing costs and move taxes may be charged twice (once when the EAT takes title and a second time when the EAT transfer the residential or commercial property to the taxpayer). In addition, the exchange fees will be greater and the loan may be more costly.

PREPARING FOR A BUILD-TO-SUIT EXCHANGE

For those intending to do a build-to-suit exchange, preparing ahead is important. First, consist of a provision in the agreement to purchase the replacement residential or commercial property that the agreement is assignable in connection with a 1031 exchange.

It is also important to get in touch with the EAT and any loan provider early while doing so, particularly if the financier means to borrow cash to get the replacement residential or commercial property or for building. Since the EAT will be on title, it will be signing the loan files and the lending institution should be willing to work together in the build-to-suit exchange. The EAT must have no individual liability for any loan responsibilities. If the loan is to be fully or partly option, the financier can sign a warranty.

Getting an accurate estimate of the quantity of time it will require to complete the building task is very important, as it will affect whether can be included the 180 day period to make the exchange worthwhile. Although the construction does not have to be complete at the expiration of the 180 day duration, the only enhancements that will impact the worth of the replacement residential or commercial property for exchange functions are the enhancements that are done since the date that the EAT transfers the replacement residential or commercial property to the investor.

Finally, investors ought to seek advice from their tax advisors before doing any exchange, especially a build-to-suit exchange. By correctly structuring a build-to-suit exchange, and by utilizing a trusted certified intermediary like First American Exchange Company, the investor may have a lot more flexibility in discovering proper residential or commercial properties and at the very same time entirely defer all capital gains tax.
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