Forward or Deferred 1031 Exchange

In a forward 1031 exchange, the taxpayer and the qualified intermediary (QI) establish an exchange agreement before any sales transaction occurs. The taxpayer transfers their rights to sell the relinquished property to the QI, who then acts as the seller and holds the funds in an exchange account for the taxpayer's benefit. Within the first 45 days of the exchange, the taxpayer must identify potential replacement properties, and once a replacement is chosen, the rights to acquire it are assigned to the QI. The taxpayer must close on the replacement property no later than 180 days after closing the relinquished property. After negotiating and executing a purchase contract with the seller of the replacement property, the taxpayer assigns the rights to purchase it to the QI. Finally, the funds from the exchange account are sent directly to the closing agent, enabling the taxpayer to receive their tax-deferred property and complete the exchange.

Build-to-Suit & Improvement Exchanges

A Build-to-Suit Exchange (BTS), sometimes called a Construction Exchange, is where an Exchanger purchases land to build the desired structure as the Replacement Property. An Improvement Exchange entails the Exchanger purchasing Replacement Property with the intention to improve the structure. Once the Exchanger takes title to the property, any improvements are considered payment for labor and materials and such payment is not the purchase of like kind property.

Process of a Build-to-Suit/Improvement Exchange

In order to have a valid Build-to-Suit/Improvement Exchange, the Exchanger must utilize the exchange funds for the construction or improvement costs within the 180 day exchange period. They do not need to be completed during this period. Similar to a Reverse Exchange, an Exchange Accommodation Titleholder (EAT) creates a Special Purpose Entity (SPE), typically an LLC, to take legal title to the property during the period of construction. The SPE will take title to the Replacement Property on behalf of the Exchanger and “park” the title until the earlier of the construction or improvements being completed OR the 180th day. Once the EAT transfers ownership of the property to the Exchanger, the Exchanger has acquired improved like-kind real estate including the increased value of the improvements.

Other Considerations

Build-to-Suit and Improvement Exchanges can be set-up on a forward or reverse basis. If the Exchanger sells the Relinquished Property prior to acquiring the Replacement Property then a forward type parking arrangement would occur and the EAT would fund the cost of the property acquisition and improvements from the exchange funds held from the Relinquished Property sale.

Alternatively, if the Exchanger acquires the Replacement Property prior to the sale of their Relinquished Property, a reverse parking exchange would occur and the Exchanger would have to provide the EAT the funds personally for property acquisition and improvements or arrange for a bank loan. In either case, the loan would be paid back at the time the Exchanger sells the Relinquished Property and funds the exchange account.

Reasons for Build-to-Suit or Improvement Exchanges

Below are a few of the reasons or factors that contribute to the need for a Build-to-Suit or Improvement Exchange:

• Utilize All Exchange Funds

  The primary reason to utilize these types of exchanges is to be able to utilize all the funds in the exchange account. Often the purchase price of the Replacement Property is less than the sale price of the Relinquished Property. The cost of the desired improvements can be made with the excess funds enabling the Exchanger to avoid “boot” and a taxable event.

• Meet Specific Criteria

  Frequently a BTS is used when the Exchanger has specific criteria for the business use property, such as a factory or place of business, and is unable to find a pre-existing property that fits those needs so the Exchanger must construct or improve to satisfy the specific property requirements.

• Competitive Real Estate Market

  In a competitive market, finding desirable Replacement Property within the 45-day Identification Period can be difficult. Build-to-Suit/Improvements Exchanges allow for a larger pool of potential Replacement property given the ability to customize the property as needed.

• Cost Savings

  Sometimes the Exchanger is able to find vacant property that can be acquired and constructed at a cost less than the sale price of a comparable already constructed property.

Reverse (Parking) 1031 Exchanges

A Reverse or Parking Exchange is where an Exchanger purchases their Replacement Property prior to selling their Relinquished Property. The typical order of events in a 1031 Exchange occur in reverse, hence the name.

Process of a Reverse Exchange

In order to have a valid Reverse Exchange, the Exchanger cannot own the Relinquished Property and the Replacement Property at the same time. Therefore, the transaction must be structured such that they sell the Relinquished Property prior to acquiring the Replacement Property. Typically, this is accomplished by having an “Exchange Accommodation Titleholder”, or EAT, acquired the Replacement Property. The EAT will hold title to the Replacement Property in a Reverse Exchange until the Exchanger sells the Relinquished Property, at which time the EAT then transfers the title back to Exchanger to complete the Reverse Exchange process.

Other Considerations in a Reverse Exchange

Some additional considerations for a Reverse Exchange include determining which property to “park” with the EAT. When parking the Replacement Property with an EAT the amount needed to acquire the property is a certain sum; however, if you are parking the Relinquished Property the amount is usually a best guess, which later requires adjustments to deal with the deviations. Therefore, traditionally the Replacement Property is “parked” with the EAT in a Reverse Exchanges.

Some reasons why a Relinquished Property would be “parked” include:

• If the value of the Relinquished Property is much less than the Replacement Property making the loan to the EAT more easily attained

• If the Replacement Property requires special financing

• If the Replacement Property lender will not lend to an LLC

• If the Replacement Property has environmental issues or concerns