A 1031 is a terrific tool for financiers who want to prevent paying tax on the gain from the sale of genuine estate; nevertheless, in order to completely postpone the tax, a financier should discover one or more replacement residential or commercial properties with an overall reasonable market value that equates to or surpasses what is being offered, and need to utilize all the money from the existing residential or commercial property and invest it in the new residential or commercial property. Many experienced real estate investors who recognize with 1031 exchanges don't realize that a build-to-suit exchange can provide more flexibility in structuring their transactions to satisfy these requirements.

The build-to-suit exchange permits an owner to utilize the earnings from the sale of the relinquished residential or commercial property not just to get replacement residential or commercial property, but likewise to make improvements to the residential or commercial property. For example, if an investor sells relinquished residential or commercial property with a fair market value of $1 million, debt of $200,000 and equity of $800,000, he needs to acquire a residential or commercial property equivalent to a minimum of $1 million and needs to invest at least $800,000 into that residential or commercial property. In a build-to-suit exchange, nevertheless, the investor might acquire residential or commercial property worth just $300,000, borrow an extra $200,000 and spend the remaining $500,000 of exchange profits plus the $200,000 in loan funds on improvements to the residential or commercial property. This would use up the staying cash and increase the reasonable market price of the replacement residential or commercial property to $1 million, resulting in a completely tax-deferred exchange.

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 enhancements are being made. The EAT is usually a restricted liability company owned by a Certified Intermediary (QI). The EAT is essential due to the fact that any work done to the residential or commercial property after the financier takes title to it is ruled out like kind residential or commercial property and for that reason will not increase the worth of the residential or commercial property for exchange purposes.

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

In a postponed build-to-suit exchange, the relinquished residential or commercial property is dealt with and the sale continues go to the qualified intermediary. The financier should determine what is to be acquired within 45 days, consisting of a description of what will be constructed on the residential or commercial property. The EAT acquires the residential or commercial property using the exchange funds. The investor manages the construction of the enhancements and regularly 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 financier on the quicker of when the building is complete, when the 180 days expires or when adequate value is contributed to the replacement residential or commercial property for complete tax deferment.

In a reverse build-to-suit exchange, the replacement residential or commercial property is gotten by the EAT initially, using funds from the financier or a loan provider. As with a deferred exchange, the investor monitors the building and construction and sends billings to the EAT, however the EAT needs to borrow money from the loan provider or the investor to pay the invoices. At some time throughout the 180 day period, the relinquished residential or commercial property is sold and funds are transferred to the QI. If there is more building required, the exchange funds can be used for the building till the 180 day period ends. Just like the deferred build-to-suit, the replacement residential or commercial property is moved from the EAT to the financier on the quicker of when the building and 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.

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

The benefits of doing a build-to-suit exchange consist of the ability to buy residential or commercial property that is lower in worth compared to the relinquished residential or commercial property and the capability to use exchange funds rather than loan proceeds to money building and construction.

The primary downside of doing a build-to-suit exchange is that the work needs to be done within the 180 day duration in order to have any impact on the exchange. For most large building jobs, this is tough; however, smaller sized projects or improvements to existing structures can often be accomplished within the required timespan. In addition, build-to-suit exchanges are more pricey than regular deferred exchanges, because the EAT will take title to the replacement residential or commercial property, which leads to an additional genuine estate transfer. Escrow costs, closing expenses and move taxes may be charged twice (as soon as when the EAT takes title and a second time when the EAT move the residential or commercial property to the taxpayer). In addition, the exchange charges will be greater and the loan may be more costly.

PREPARING FOR A BUILD-TO-SUIT EXCHANGE

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

It is also crucial to contact the EAT and any lender early at the same time, especially if the financier intends 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 documents and the lending institution should want to work together in the build-to-suit exchange. The EAT should have no personal liability for any loan obligations. If the loan is to be totally or partly option, the investor can sign a guaranty.

Getting an accurate quote of the quantity of time it will take to complete the building job is essential, as it will affect whether sufficient worth can be included the 180 day period to make the exchange worthwhile. Although the building and construction does not have to be total at the expiration of the 180 day duration, the only enhancements that will impact the value of the replacement residential or commercial property for exchange functions are the improvements that are done as of the date that the EAT transfers the replacement residential or commercial property to the investor.

Finally, investors need to seek advice from with their tax consultants before doing any exchange, particularly a build-to-suit exchange. By appropriately structuring a build-to-suit exchange, and by using a trusted certified intermediary like First American Exchange Company, the financier may have a lot more flexibility in discovering appropriate residential or commercial properties and at the same time completely postpone all capital gains tax.

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