1031 Exchange Rules: 1031 Construction Exchange

Understand the 1031 exchange rules to make an informed decision. In a construction exchange the exchanger has found, and wants to buy, the replacement property before improvements required to meet or exceed the value of the relinquished property have been constructed.

In 2000 in Rev, Proc. 2000-36 the IRS set forth the procedures to safely accomplish what may be termed a construction 1031 exchanges.
In a construction 1031 exchange, the exchanger cannot improve upon a property that he/she already owns. Therefore either the replacement property must be held, temporarily, by a holding company known as an Exchange Accommodation Titleholder (EAT).

When the replacement property is to be held by the EAT the procedure which we follows is:

1. At the time of the sale of the relinquished property, 1031x.com, Inc. will act as Qualified Intermediary for the exchanger and escrow the funds from the sale of the relinquished property. Net proceeds from the sale of the relinquished property will be used to buy replacement property and for improvements to this property.

2. Our Limited Liability Company buys the replacement property. The LLC will act in the capacity of an “Exchange Accommodation Titleholder” (EAT) as that term is defined by the IRS. The EAT and the exchanger will enter into a real estate holding contract termed by the IRS a “Qualified Exchange Accommodation Arrangement” (QEAA). The QEAA will outline the obligations of the EAT and the exchanger during the real estate holding period.

3. Our LLC will purchase the replacement property by borrowing 100 percent of the needed funds. We can borrow the funds from any source authorized by the exchanger. The easiest source of borrowed funds in the exchanger themselves. However, we can borrow from any source. The lender is protected by a note and deed of trust on the replacement property. Finding a lender for a construction exchange can be difficult. Please contact us is you need help finding a lender.

4. Our LLC will also lease the replacement property to the exchanger during the construction period, or for 180 days, whichever occurs first. Lease payments from the exchanger to Our LLC will correspond in amount to mortgage payments made by Our LLC.

5. Our, LLC will also agree to re-sell the replacement property to the Exchanger closing to occur no later than 180 days after Our, LLC acquires the replacement property. The 180 day time limit for completing a construction 1031 exchange is set by the IRS.

6. The exchanger actively manages the improvements to the replacement property. At the time the improvements meet or exceed the value of the exchanger’s relinquished property, 1031x.com, Inc. will act as Qualified Intermediary for the exchanger and escrow the funds from the sale of the relinquished property. Net proceeds from the sale of the relinquished property will be used to buy replacement property, from Our LLC. THE NET EFFECT OF THIS WILL BE SIMPLY TO SHIFT ALL EQUITY FROM THE RELINQUISHED PROPERTY TO THE REPLACEMENT PROPERTY. In the end this looks very much like a forward exchange with us having captured and held the replacement property.

Finally, let me explain what happens when a construction exchange fails. Our real estate holding agreement states that we will transfer whatever property we are holding to you at the end of 180 days. You end up owning replacement property with its new improvements. If the total value of the property does not meet or exceed the value of the relinquished property, you will need to pay taxes on the difference up to the amount of your total capital gains.
I hope that you find this summary of procedure helpful. Please contact us if you have any questions.

Contact us for help with your construction exchange. Exchanges are our business!