Improvement 1031 Exchange

In order to enable the investors to save or defer taxes incurred on the sale of property, the United States Internal Revenue Code provides a spate of options under Section 1031. Improvement exchange is one such important method for the same. Abiding by the 1031 improvement exchange definition, it allows the exchanging person utilize the exchange proceeds to build or make improvements to the replacement property. Also known as improvement starker exchange, it can take place in the context of a reverse or a delayed exchange and helps the taxpayer to buy a replacement property, which needs improvement, or to purchase a bare land and build part of it or whole, as per the requirement.

Doing an improvement 1031 exchange

Usually, an Exchange Accommodation Titleholder (EAT), which is most of the times, an exchanger firm, performs this improvement on behalf of the exchanging person. The EAT then transfers the improved replacement property back to the exchanger within 180 days of exchange period. The construction is however done in accordance with the building specifications, as agreed upon in the contract. It is not necessary for the improvements initiated in the real property to complete within the exchange period. However, the portion of the improvement that remains incomplete as per the outlined specifications of the building will cease to qualify as a replacement property.

In case if the exchange period of 180 days falls short, a delay in the transfer of the relinquished property may help the period to extend even further. This could in turn give some time to carry out the improvement work on the replacement property. The property that needs to be shown in the construction exchange, but has not been completed within 180 days, must be included as a portion of the standing structure. Under the local law, this very standing structure is considered as real property.

What are the requirements for a successful improvement 1031 exchange?

The IRS improvement exchange requires the exchangers to fulfill three important requirements in the wake of deferring all their gains on the relinquished property. These include:

•  To mind the exchange period:   All the proceeds obtained from the sales of relinquished property must be used to complete the improvements on the replacement property or to make the down payment. The main thing here is to abide by the 180 day exchange period. Hence, it is important to take care of the 1031 exchange improvement timing.
•  To receive the correct improvement exchange property:   A substantial requirement to abide by 1031 improvement exchange rules is to receive the same property that has been identified in the 45-day exchange period.
•  To ensure high value of the replacement property:   During the transfer of the replacement property to the exchanging person, it is essential for the replacement property to be greater or at least equal to the sum of original cost of the relinquished property and the proceeds used for improvement work.  This particular requirement for exchange value is termed as Napkin Test.

Conditions to adopt 1031 improvement exchange rules

There may be many circumstances in which the 1031 improvement exchange rules could prove to be a feasible solution, ahead of all the other exchange methods. Some of these conditions are given below:

The Napkin Test fails:  The exchange property that needs to be acquired fails the Napkin test, i.e., the property does not have the value equal to or more than the relinquished property. In such a condition, 1031 improvement exchange could help the exchanger to avoid the taxable situation. The exchanger could add capital improvements to a new replacement property, which he does not own so far.

  Build a new investment:  In this option, the exchangers build their own replacement property afresh, hence adding wings to their investment opportunity. It sets the exchangers free from abiding by the terms of the market and seller, and lets them to build a new property.

  Refurbishment of new property:  If the new investment is able to pass the Napkin Test satisfyingly, but needs an overhaul, yet again the 1031 improvement exchange of properties comes into effect. It helps significantly in refurbishing the new property, by using tax-free money yet again.

Why opt for improvement 1031 exchange firms?

The entire concept and its implementation is a bit complex and hence desires the intervention of one of the experienced improvement 1031 exchange companies. Approaching any of these improvement 1031 exchange firms sets you free from the involved hassles as it acts as the exchanger on your behalf (or the intermediary), and takes care of the involved documentation, paperwork and the construction work on the replacement.

Summary:  On the way toward deferring the tax payment on property investment, 1031 improvement exchange rules play an effective role. It involves the use of proceeds from the relinquished property to invest in the improvement of replacement property according to a specific construction plan as decided in the agreement 1031 improvement exchange agreement. The role of improvement 1031 exchange firms is also of great significance.

At Triple Net Investment Group we can assist you in locating a like-kind property for a 1031 exchange and ensure a smooth and successful transaction.