1031 Exchange for New Construction
New construction, when combined with a 1031 exchange, is a remarkable opportunity for significant tax advantages and investment growth opportunities. At 1031 Pros, you’ll get expert management of new construction exchanges, allowing investment in tailored real estate projects.
What is a New Construction 1031 Exchange?
Also called Build-to-Suit or improvement exchanges, these let you use the proceeds from the sale of a relinquished property for new construction, improvements, and renovations on a like-kind property. If the value of the replacement property is less than the one you sell, improvements can increase the value enough to meet the requirements for full deferral of capital gains taxes.
Benefits of New Construction 1031 Exchanges
In a traditional 1031 exchange, you simply buy a like-kind replacement property; in a new construction exchange, you also use some of the proceeds from the sale to make improvements on the new property. This could include adding new buildings, renovating existing structures, or even building from scratch.
In total, the value of the replacement property (including improvements) must equal or exceed the value of the relinquished property. Making improvements allows for significant property appreciation, so long as the transaction is properly structured.
Eligibility and Requirements for a Construction 1031 Exchange
As with all 1031 exchanges, the property must be for business or investment use and you must complete the transaction within a time frame. This can sometimes be challenging, as the replacement property must be identified within 45 days of the sale of your relinquished property, and acquired by the buyer within a total of 180 days.
The replacement property must include not only a description of the real estate in its current form, but also as much detail as possible about the intended improvements.
Financial Planning for New Construction 1031 Exchanges
To fully defer capital gains taxes, all of the exchange equity must be invested in products and services on the new property; any unused funds are taxable. Exchange Funds that have been placed in escrow for post-closing improvements do not qualify, even if the funds are deposited before you take the title.
If the exchange funds do not cover the acquisition and improvement of the new property, additional funds can be loaned to 1031 Pros as the Qualified Intermediary, who in this type of exchange also acts as your Exchange Accommodation Titleholder (EAT). If you need a construction loan from an institutional lender, you should seek lender approval prior to starting the exchange. You can also partner with your developer, using a construction reserve in the exchange account.
Acting as project manager for the construction, you will send invoices to 1031 Pros, as your EAT, to be paid directly to your vendors. During the exchange period, you cannot be reimbursed for any advances or expenses incurred. As you are allocating a budget for the construction project, always be aware of potential cost overruns!
Construction 1031 Exchanges, Step by Step
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Contact 1031 Pros for advice on structuring your New Construction 1031 Exchange.
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Because Section 1031 does not allow you to own both properties at the same time, you will sell the relinquished property through 1031 Pros, acting as your EAT, or in some cases acquire the replacement property first through a parking agreement.
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We will set up a special purpose entity, often a single member limited liability company, that is used to acquire and park the title to your replacement property during the exchange.
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We will work with you to use exchange funds to improve the new property.
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At the end of the exchange, the new property and any construction loans will often be transferred to you through the holding entity, rather than by a deed. We will work with you to ensure compliance with all tax and other legal issues.
Choosing the Right Property and Location for a New Construction 1031 Exchange
As with all real estate transactions, you will want to look at the economic stability of the area where your new property is located, as well as local demand for the type of your new construction.
It’s important to understand market trends and future growth potential, and we’ll work with you to help make sure that you select the right replacement property.
After Your New Construction 1031 Exchange
As experts in 1031 exchanges, we offer ongoing support including help with long-term investment strategies, access to a network of property managers, real estate companies, and financial experts to make the most of opportunities.
Potential Risks of New Construction 1031 Exchanges
The Ticking Clock
In order for you to have a successful exchange, the 180 day timeline is a hard and fast rule – and with new construction there are often delays during project improvements. It is important to engage experienced contractors and maintain contingency plans. We’ll help you with smart planning for your exchange.
Market Changes
Changes in market conditions during construction can happen, potentially reducing the replacement property’s value. Conducting thorough market and feasibility studies is wise. We’ll help you set strategies in place to mitigate this risk.
Financial Challenges
Construction projects also often experience budget overruns, so it’s important to plan for them. If you are taking out a construction loan to make improvements to the new property, finding a lender who is familiar with 1031 exchanges and comfortable with construction loans can be a challenge. We’ll help you navigate the process and set you up for success.
Legal and Regulatory Compliance
We implement strict internal controls to ensure full compliance with state and federal regulations, including recent updates to laws affecting 1031 exchanges. At the close of your exchange, we also provide you with all necessary tax documents so you can benefit from a fully deferred tax exchange.
We Are Experienced Qualified Intermediaries in New Construction 1031 Exchanges
At 1031 Pros, we are ready to bring our knowledge and expertise to your Build-to-Suit 1031 Exchange. We are specialists at setting up special purpose entities that will protect you from any liens and judgments, coordinating between parties, managing construction funds, and ensuring compliance with all 1031 rules.