What Is An Improvement Exchange?
The Improvement Exchange empowers an investor with the ability to acquire precisely the property they wish. Improvements can be as simple as repairs to current structures or as complex as ground-up new construction. The Improvement Exchange opens up many opportunities to the savvy investor, even the possibility of improvements to property already owned.
While escrow holdbacks or pre-payment of labor and materials are natural paths in getting improvements done, they do not qualify for tax deferral.
Improvement Exchange Options
Any exchange involving improvements must be carefully planned. The Exchangor has three options available in making the desired improvements.
- The easiest and least expensive solution is to have the current owner perform the improvements. The cost of the improvements is added to the purchase price for the property. This strategy allows the completion of a basic simultaneous or delayed exchange. The seller may be unwilling to participate because his basis and sales price will most likely be increased by the cost of the improvements.
- Another option is to have a developer or other entity acquire and develop the desired property. This strategy can yield a basic simultaneous or delayed exchange, yet often gets very complicated. Usually funding of the project is a primary concern. Contracts must be drawn to provide the Exchangor with assurance for completion. Often exchange proceeds are used for the improvements. If the exchange proceeds are used, the facilitator must be on the construction contracts.
- The final choice is to have the facilitator take title to the replacement property using an EAT (exchange accommodation titleholder) as the owner constructing 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 and easier to complete option.
What About Improving My Existing Property?
Often investors inquire whether they can use exchange proceeds to make improvements to property already owned. Although not considered a conservative option, there are several “liberal” letter rulings that recognize this strategy. Equity Advantage has facilitated many construction exchanges of this format and upon request, will provide information to support this approach.
Steps to Improving Property Already Owned
- Sell your property. The real estate sale’s contract must have a paragraph stating that the sale is subject to a 1031 exchange and that the buyer agrees to cooperate with the exchange (1031 exchange cooperation clause).
- Contact Equity Advantage, Inc. when the real estate sale contract is final. Provide the name and phone number of your realtor and the name of the title company of where escrow is opened. We will work directly with the title company on securing your exchange documents.
- Sign the Exchange Agreement stating that Equity Advantage Inc. will serve as your 1031 Accommodator. You will have the opportunity to sign these documents at the title company when the closing is scheduled.
- Closing occurs. Equity Advantage, Inc. will direct deed your relinquished property to the buyer.
- The escrow company will forward the sale proceeds to Equity Advantage, Inc. We will deposit the proceeds into a federally deposited bank account.
- Identify your Replacement Property. Measured from the closing date of the relinquished property, you now have 45 days in which to identify your Replacement Property. The Replacement Property includes the improvements. Your identification will need to be in writing and forward to my office. For example, the identification might read “the construction of a single level 2300 sq. foot house, 3 bedrooms, 2 baths (blue prints attached) on a lot located on beachfront Street currently owned by Mr. and Mrs. Smith.”
- Equity Advantage, Inc. will create a LLC where the only member of the LLC is Equity Advantage, Inc. The sole purpose of the LLC is to take title to your Replacement Property.
- Equity Advantage drafts a lease where you are the landlord and the LLC is the tenant. The lease term will be for 35 years. The leased property is both the property you own and the improvement to that property.
- The lease provides that the LLC (as tenant) has the authority to make improvements to the property owned by you. The LLC signs a construction contract with the general contractor that you have selected.
- Construction begins. Review any invoices incurred for the improvements. Submit the invoices and written approval of the invoices to Equity Advantage, Inc. The LLC will pay the invoices pursuant to your written authorization.
- At the end of the 180-day period, The Advantage Equity LLC will assign its tenancy (lease) to you. It will also quitclaim the improvement to you as well. The exchange is complete.
IMPORTANT: Information presented here is provided only as a general resource. It is not intended to provide tax or legal advice for specific facts or particular circumstances. 1031 exchanges are very complex transactions with potential for serious tax implications. It is recommended you seek the advice of a certified tax professional or a lawyer.
Support Retention of 1031 Exchanges!
Tell your elected officials how Section 1031 like-kind exchanges have benefited you, your business, and your community! Section 1031 has been a vital part of everyday business transactions U.S. tax policy since 1921.
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The Guys With All The Answers…
David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
If you’re considering a 1031 exchange, you want a team of professionals on your side. Let the experts at Equity Advantage help you navigate the details. Call them today! 503-635-1031.