Build-To-Suit Exchanges: Utilizing Exchange Funds for Improvements on your Replacement Residential or Commercial Property

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A 1031 exchange is a great tool for financiers who wish to prevent paying tax on the gain from the sale of property; nevertheless, in order to entirely delay the tax, an investor should discover several replacement residential or commercial properties with a total reasonable market value that equals or surpasses what is being offered, and need to utilize all the cash from the existing residential or commercial property and invest it in the brand-new residential or commercial property. Many experienced investor who are familiar with 1031 exchanges do not understand that a build-to-suit exchange can offer them more versatility in structuring their deals to fulfill these requirements.

The build-to-suit exchange allows an owner to use the proceeds from the sale of the given up residential or commercial property not just to get replacement residential or commercial property, but also to make enhancements to the residential or commercial property. For instance, if a financier sells relinquished residential or commercial property with a reasonable market worth of $1 million, debt of $200,000 and equity of $800,000, he should obtain a residential or commercial property equivalent to a minimum of $1 million and must invest a minimum of $800,000 into that residential or commercial property. In a build-to-suit exchange, however, the investor might acquire residential or commercial property worth just $300,000, obtain an $200,000 and invest the remaining $500,000 of exchange profits plus the $200,000 in loan funds on improvements to the residential or commercial property. This would consume the staying money and increase the fair market price of the replacement residential or commercial property to $1 million, resulting in a completely tax-deferred exchange.
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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 improvements are being made. The EAT is generally a restricted liability company owned by a Competent Intermediary (QI). The EAT is essential since any work done to the residential or commercial property after the investor 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 functions.

A build-to-suit exchange can be structured either as a deferred exchange where the existing residential or commercial property is sold before the new residential or commercial property is gotten, or a reverse build-to-suit, where the brand-new residential or commercial property is obtained first. In either case, the whole deal must be finished within 180 days.

In a deferred build-to-suit exchange, the relinquished residential or commercial property is dealt with and the sale continues go to the certified intermediary. The financier must determine what is to be acquired within 45 days, consisting of a description of what will be built on the residential or commercial property. The EAT acquires the residential or commercial property utilizing the exchange funds. The financier oversees the building and construction of the enhancements and occasionally sends out invoices to the EAT, who pays them using exchange funds. The replacement residential or commercial property is transferred from the EAT to the investor on the quicker of when the construction is total, when the 180 days ends or when enough worth is contributed to the replacement residential or commercial property for complete tax deferral.

In a reverse build-to-suit exchange, the replacement residential or commercial property is obtained by the EAT initially, utilizing funds from the investor or a lending institution. Similar to a deferred exchange, the investor monitors the building and construction and sends out billings to the EAT, however the EAT must obtain money from the lending institution or the investor to pay the invoices. At some time during the 180 day period, the given up residential or commercial property is sold and funds are moved to the QI. If there is more building and construction needed, the exchange funds can be utilized for the building and construction up until the 180 day duration ends. As with the deferred build-to-suit, the replacement residential or commercial property is moved from the EAT to the investor on the sooner of when the building is total, when the 180 days expires or when adequate worth is included to the replacement residential or commercial property for full tax-deferral.

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

The advantages of doing a build-to-suit exchange include the ability to purchase residential or commercial property that is lower in value compared to the given up residential or commercial property and the ability to use exchange funds instead of loan earnings to money building.

The principal drawback of doing a build-to-suit exchange is that the work should be done within the 180 day duration in order to have any impact on the exchange. For most big building and construction tasks, this is hard; however, smaller tasks or improvements to existing structures can often be accomplished within the required amount of time. In addition, build-to-suit exchanges are more costly than regular deferred exchanges, since the EAT will take title to the replacement residential or commercial property, which results in an extra real estate transfer. Escrow costs, closing expenses and move taxes may be charged two times (as soon as when the EAT takes title and a 2nd time when the EAT transfer the residential or commercial property to the taxpayer). In addition, the exchange charges will be higher and the loan might be more costly.

PLANNING FOR A BUILD-TO-SUIT EXCHANGE

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

It is likewise crucial to call the EAT and any lender early while doing so, particularly if the financier means to obtain money to obtain 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 lender must want to work together in the build-to-suit exchange. The EAT must have no personal liability for any loan responsibilities. If the loan is to be completely or partially recourse, the financier can sign a guaranty.

Getting a precise price quote of the amount of time it will require to finish the construction project is very important, as it will affect whether sufficient value can be added in the 180 day period to make the exchange rewarding. Although the building does not have to be complete at the expiration of the 180 day period, the only improvements that will impact the value of the replacement residential or commercial property for exchange purposes are the enhancements that are done as of the date that the EAT transfers the replacement residential or commercial property to the investor.

Finally, investors must speak with their tax advisors before doing any exchange, particularly a build-to-suit exchange. By effectively structuring a build-to-suit exchange, and by using a trusted competent intermediary like First American Exchange Company, the investor might have much more versatility in discovering proper residential or commercial properties and at the same time entirely defer all capital gains tax.

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