Build To Suit
What happens when you cannot find a replacement property
that is worth the same price of what you sold in a 1031 exchange? One option is
to make improvements to the property being purchased. You can literally build
the property to suit your needs or the needs of a potential tenant.
Essentially, you can use exchange funds to pay for the
improvements made to the property that can be accomplished before the 180th day
of the exchange. It is almost that simple if you are only dealing with a sale
that is free and clear. The only factors that can complicate this have to do
with debt and lending issues.
The Process?
In simple terms, the Qualified Intermediary (QI) steps
into title during the initial purchase, acts as a general contractor to
facilitate the payment of improvements, repairs, and even some personal
property that is added property. Then, as soon as the work is completed, or we
reach the 180thday, that improved property is conveyed to the
exchanger to complete the purchase leg of the exchange.
What Improvements Can Count?
Virtually any capital improvements can count towards the
value being added to the property. The QI cannot directly pay the exchanger for
labor and the value of improvements is simply their cost. As mentioned earlier,
personal property can be included, as long as its value does not exceed 15% of
the total value of the finished property. An extreme example was the purchase
of a fork lift for use in a warehouse being improved in an exchange, or a lawn
mower purchased for a rental.
What If the Improvements Are Not Completed?
The property does not need to be
habitable to qualify; it simply needs to be attached. A lumber package sitting
in the driveway is only personal property until it is attached to the land.
There is no inspection required; you only need proof that the money was spent.
Guidelines and case examples use the “snap shot rule”. In other words, if you
were to take a photo on the last day of the exchange, whatever is visibly
completed can be counted.
Use of an LLC
Very often forming an LLC for the process
of an Improvement Exchange is an effective way to package the improvements and
tie them to the property. Any agreements made with any contractors during the
process would remain in effect, and the final transfer of the improved property
are smoothly conveyed by a simply Assignment of LLC Interest.
Happy Investing!
Today's blog is courtesy of Kevin Hummel, McFerran & Burns, PS.
