1031 Improvement Exchanges: Tax-Efficient Property Upgrades
Did you know that you can use a 1031 exchange as a strategic way to enhance property value with improvements while deferring taxes? It’s called a 1031 improvement exchange and lets you use some of the proceeds from the sale of a relinquished property to make rehabilitations and renovations to a replacement property. This guide will help you know how to allocate exchange funds effectively in a way that not only improves the property, but also lets you defer capital gains tax.
What is a 1031 Improvement Exchange?
Traditional 1031 exchanges let you sell a property that you own for business use or investment purposes, and use the proceeds from the sale to buy a like-kind property without paying capital gains taxes. Reverse 1031 exchanges reverse the process: they are for when you buy a replacement property before you have closed on the sale of your relinquished property.
A 1031 improvement exchange adds another layer, letting you use funds from the sale of your relinquished property for improvements on a like-kind property. If the value of the replacement property is less than the one you sell, improvements can be used to increase the value enough to meet the requirements for full deferral of capital gains taxes. Improvement exchanges can be either traditional or reverse exchanges.
Benefits of Improvement Exchanges
One tremendous benefit of a 1031 improvement exchange is that it lets you use pre-tax dollars to increase the property value of your new, replacement property through enhancements to existing structures. This allows for significant property appreciation.
The proceeds from the sale of your relinquished property that are used toward the acquisition and improvement of your replacement property, as well as those proceeds that are paid or used for the improvements, will qualify for tax deferred exchange treatment provided the transaction is properly structured as a 1031 improvement exchange.
Detailed Process for a 1031 Improvement Exchange
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Contact 1031 Pros for advice on structuring your 1031 improvement 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 a qualified intermediary and Exchange Accommodation Titleholder (or EAT), or in some cases acquire the replacement property first through a parking agreement.
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As your qualified intermediary, 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 replacement property.
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At the end of the exchange, the replacement 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.
Regulatory Guidelines and Compliance
All of the proceeds from the sale of your relinquished property must be used to acquire and improve the replacement property, in order to qualify for tax deferral.
Also, you must adhere to a strict timeline: there is a 45-day timeline for identifying a replacement property and a 180-day timeline for completing the exchange. If you miss these deadlines, you are responsible for paying capital gains taxes on the sale of your relinquished property. At 1031 Pros, we will help you navigate the complexities of exchanges successfully.
Project Planning and Execution
As with all construction and renovation projects, there can be costly delays. It is important to plan for these and work closely with your contractors and vendors in order to make sure that the 180 day deadline is met. This means reviewing plans, specs, and project documents, going over every detail of the scope of work.
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It is also helpful to create and coordinate a master schedule with all parties and refer to it often, modifying it as needed, and implementing contingency plans that you have put in place. From there, communication and collaboration are key! You want to get regular updates on progress, monitored and documented, to ensure that you meet the deadline.
Financial Considerations and Risk Management
Improvement 1031 exchanges can be more complicated and costly than traditional 1031 exchanges, so be aware of the amount of depreciation recapture and capital gains tax liabilities that are being deferred, to ensure that the cost of the improvement exchange is worthwhile.
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.
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If the exchange funds do not cover the acquisition and improvement of the new property, additional funds can be loaned to 1031 Pros as your qualified intermediary and 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.
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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!
At every step of the way, 1031 Pros is here to help.
Choosing Properties Suitable for Improvement Exchanges
Before entering any real estate transaction, you will want to look at the economic stability of the area where your replacement property is located, as well as gauge local demand for the type of your improvement project. Finding a property in a high-growth area is ideal, as well as one that allows significant value-add through the improvements, or even one that is under market value with high upside potential. 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.
Call Us for a Free Consultation
Our customer service is unmatched in the industry, including a live person answering the phone when you call at any time, 24/7, and responses to emailed questions within 24 hours. Contact us at 916-252-6900 for a free consultation before starting your 1031 improvement exchange, or even to discuss long-term strategies for your portfolio, to ensure that you are set up for success.
Real Customers, Real Stories
"I was very pleased with your promptness and quick turnaround on everything. You have gained my business for future transactions and referrals. Thank you.”
– Jake Gress
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Can I use a 1031 exchange for a property I occasionally use for personal vacations?Yes you can, so long as you rent the property for more than 14 days per year for the first two years, and use it for personal use fewer than 14 days per year and no more than 10% of nights rented. Got questions? Call us at 916-252-6900 and our 1031 vacation home exchange experts will walk you through the details.
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What are the IRS rules for using a vacation home in a 1031 exchange?At the time of the 1031 exchange, the primary intent of the investor to use the replacement property for investment purposes is the determining factor as to whether it is for personal use or as an investment. Also, only dwelling units are eligible for these exchanges. For more details, contact us at 916-252-6900 for a free consultation on setting the right strategy for your 1031 vacation home exchange.
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How long must I hold a property before it qualifies for a 1031 exchange?There is not a specific amount of time that you must hold a property before using it in a 1031 exchange, but the IRS will look at your intent – you must have had the intention to use the property for investment purposes, which could include renting the property at a fair market value.
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What are the potential tax consequences if my vacation home does not qualify?If your vacation home does not qualify, you may be responsible for paying capital gains taxes on the sale of your relinquished property.
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Can I use a 1031 vacation home exchange for international properties?We can handle 1031 exchanges of all types, including those of foreign property with like-kind property both at home or abroad. Call us at 916-252-6900 to learn more.
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How much does a 1031 vacation home exchange cost?Pricing is determined on an individual basis, but at 1031 Pros we offer competitive prices and are willing to match anyone else’s offer.
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What is a reverse 1031 exchange and how does it differ from a traditional exchange?In a traditional 1031 exchange, you sell a property (known as the relinquished property) and then buy a new property of like kind (known as the replacement property for business use or investment purposes). In a reverse 1031 exchange, this order is reversed, enabling you to acquire new property before you have sold your original property.
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What are the time limits involved in a reverse 1031 exchange?You have 45 days to identify a new replacement property and 180 days to complete the exchange, or you might be liable for capital gains tax.
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What happens if I can't sell my original property after completing a reverse 1031 exchange?You might be liable for paying capital gains tax when you sell your original property.
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How do I fund a reverse 1031 exchange?It is important to ensure that you have sufficient funds to acquire the new property, including all potential fees, before you start. In some cases, you can obtain financing for reverse 1031 exchanges, but some lenders are hesitant to enter into this arrangement. We’ll work with you to explore options and mitigate risks.
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Can I use a reverse 1031 exchange for international properties?We can handle 1031 exchanges of all types, including those of foreign property with like-kind property both at home or abroad. Call us at 916-252-6900 to learn more.
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How much does a reverse 1031 exchange cost?Pricing is determined on an individual basis, but at 1031 Pros we offer competitive prices and are willing to match anyone else’s offer.
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What type of property qualifies for a 1031 exchange?Any property held for productive use in a trade or business or for investment can be exchange for like-kind property. "Like-kind" refers to the nature of the investment. Any type of real property can be exchanged for another type of real property. For example: A single family rental can be exchanged for a duplex. Raw land can be exchanged for a shopping center or an office space for apartments. Any combination will work. This gives the investor flexibility to change investment strategies to fulfill their portfolio needs.
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What Does Not Qualify?A personal residence, developed lots, home flipping, partnership interests or property held for resale immediately after acquisition. Second homes may or may not qualify depending upon the use and how it's reported for income tax purposes.
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What kind of exchanges does 1031 pros handle?We handle all types of exchanges: Delayed Exchanges, Reverse Exchanges and Build to Suit Exchanges. From the simple to the complex, we can handle any type of exchange.
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Does 1031 Pros handle exchanges in any state?Yes. We can handle exchanges for any property in any of the 50 states.
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How much notice do I need to do a 1031 Exchange?You can do a 1031 exchange any time before closing on the sale of your investment property. Like we said before, we're fast.
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How long do I need to own my investment property before I can exchange it for another?There is no set timeline, but to avoid any issues you should at least own it for a minimum of 12 months.
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What happens if I don't close on my replacement property within 180 days?Then you just pay the capital gain taxes like your would have if you were to sell the property in the first place.
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Can I sell one property and exchange into multiple properties?Yes, in most cases you can exchange into three other properties.
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Why should I use a qualified 1031 intermediary to do my exchange?We will prepare all the correct paperwork you will need to file your taxes with. We will also ensure you meet your timelines and any other specifics of the 1031 tax code.
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What if my Title company is a qualified 1031 intermediary?1031 Pros specializes in exchanges and has the expertise, experience and history to ensure an audit free exchange.
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What is a reverse exchange?A reverse exchange is when you close on the purchase of the replacement property before you close on the sale of the relinquished property. Many real estate investors will utilize a reverse exchange to acquire a replacement property in a market where there may be competing offers or there is a need to close fast. Because of our vast experience handling these types of exchanges, we offer very competitive rates and are willing to match any competitor pricing.
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What is an improvement exchange?Also referred to as a construction exchange or build-to-suit exchange, improvement exchanges offer real estate investors nice benefits, which often result in better investment opportunities than properties readily available on the market. The ability to remodel, add capital improvements, or build from the ground up, while using tax-deferred dollars, allows an investor to reinvest in a replacement property that meets their exact investment criteria.
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What is the Federation of Exchange Accommodators?The Federation of Exchange Accommodators (FEA) is the only national trade association organized to represent professionals who conduct like-kind exchanges under Internal Revenue Code §1031. Members include Qualified Intermediaries (QIs), their primary tax and legal counsel, and affiliated industries (TIC sponsors, banks, real estate brokers, title companies, settlement/escrow agents, etc.). 1031 Pros is a proud member of the FEA.
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Can I 1031 exchange into a Tenancy in Common or Triple Net Lease Property?Yes, you can exchange into a Tenant In Common (TIC) or Triple Net Lease real estate investments. The biggest rule of thumb is that your name is on the title as an owner with a percentage of ownership. These types of real estate investments offer a great passive income for those who are done with being a landlord and are ready to sit back and collect a monthly check. We do not offer these types of investments at 1031 Pros, but we have some great partners who do. Call us today to learn more.
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Does my personal residence qualify for a 1031 exchange?No, it does not. Personal residences qualify for different tax benefits under IRS Code Section 121. Section 121 allows a taxpayer to exclude up to $250,000 ($500,000 for certain taxpayers who file a joint return) of the gain from the sale (or exchange) of property owned and used as a principal residence for at least two of the five years before the sale. 1031 Pros does not offer any services or tax advice for personal residences. Please contact our trusted Accounting partners under the "More Tab" for more information on Section 121. Tell them 1031 Pros sent you!
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Are my funds insured?Each of our exchanges uses a unique, individual, FDIC insured account. 1031 Pros also has additional bonding and insurance, so your funds are always safe and secure.
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What is considered a "like-kind" property in a 1031 exchange?A like-kind exchange occurs when you want to sell an asset and acquire a similar one, while avoiding capital gains tax. These are heavily monitored by the IRS and require oversight to ensure that no tax penalty is incurred.
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How long do I have to identify a replacement property?You have 45 days to identify a replacement property for your 1031 exchange.
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What are the tax implications if I miss the 1031 exchange deadline?If you miss the 180 day deadline, you will be responsible for paying capital gains taxes, as if it were a standard sale of real estate.
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How do I choose a qualified intermediary for my 1031 exchange?You want your qualified intermediary to be an expert on 1031 exchange regulations and well connected with property managers, real estate companies, and financial experts. You also want a highly responsive intermediary who is always available when you have a question. At 1031 Pros, we are that intermediary.
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Are there any types of real estate that do not qualify for a 1031 exchange?To qualify, the property must be a business or investment rather than personal property. Your home does not qualify under Section 1031 of the IRS tax code, nor does property held for sale (such as spec houses, building lots, and flips), stocks including those in a Real Estate Investment Trust, bonds, mortgages, and notes.
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How much does a 1031 exchange cost?Pricing is determined on an individual basis, but at 1031 Pros we offer competitive prices and are willing to match anyone else’s offer.
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What is a partial 1031 exchange, and how does it work?A partial 1031 exchange lets you sell one investment property and reinvest a portion of the proceeds into another property of like-kind, but keep part of the sale funds as cash. Because you are only reinvesting part of the money, you will be responsible for paying a portion of capital gains taxes on the sale.
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How do I calculate the tax on the cash received (boot)?Every partial 1031 exchange is unique, and we know how to handle them all. Call us at 916-252-6900 for a free consultation to discuss your situation, and we will help you calculate the taxes on cash received and create a strategy that will make your partial 1031 exchange successful.
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Can partial 1031 exchanges be used for international properties?We can handle 1031 exchanges of all types, including those of foreign property with like-kind property both at home or abroad. Call us at 916-252-6900 to learn more.
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What are the risks associated with partial 1031 exchanges?In addition to being responsible for paying a portion of capital gains taxes, there are other risks that are familiar to real estate investors – such as property underperformance and legal concerns that arise if you are not compliant with 1031 exchange regulations. When you call us for a free consultation, we will help you review these risks and set a strategy for success.
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How should I select a qualified intermediary for a partial exchange?At 1031 Pros, we are experts in all 1031 exchanges. Serving all 50 states, we will ensure that you have all of the appropriate documents, are in full compliance with regulations, are set up with a unique FDIC-insured individual account for your exchange, coordinate with your title company, and more. Unlike other qualified intermediaries, we also go the extra mile – providing access to a network of property management and real estate advisors after your exchange, and helping you create long-term investment strategies. And of course, our customer service is the number one reason that investors choose to work with us: we stay one step ahead of the process and respond quickly and accurately to questions.
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How much does a partial 1031 exchange cost?Pricing is determined on an individual basis, but at 1031 Pros we offer competitive prices and are willing to match anyone else’s offer.
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Can I use a 1031 exchange for building improvements?You absolutely can, putting funds from the sale of your relinquished property toward improvements on your replacement property with a full deferral of capital gains taxes, so long as you meet the deadlines and IRS regulations associated with 1031 exchanges.
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What is a 1031 improvement exchange, and who can benefit from it?A 1031 improvement exchange lets you use pre-tax dollars from the sale of your relinquished property to increase the property value of your new, replacement property through enhancements to existing structures. All while deferring capital gains tax.
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What are the critical timelines I need to be aware of?Your replacement property must be identified within 45 days of selling your relinquished property, and the entire transaction – including all improvements specified in the exchange – must be completed within 180 days.
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Can I handle the construction management myself?Acting as project manager for the construction, you will send invoices to 1031 Pros, as your EAT, to be paid directly to your vendors. We will work closely with you to ensure that all funds are handled correctly.
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What happens if the improvements are not completed on time?If the improvements on the replacement property are not completed within the 180 timeline, you will be liable for capital gains taxes on the sale of your relinquished property. We are experts in all aspects of 1031 exchanges; call us at 916-252-6900 to discuss your plans and we will help make sure that your exchange goes smoothly.
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How do I choose a qualified intermediary for an improvement exchange?You want to find a qualified intermediary with experience in 1031 improvement exchanges. They will ensure that you have all of the appropriate documents, are in full compliance with regulations, are set up with a unique FDIC-insured individual account for your exchange, coordinate with your title company, and more. At 1031 Pros, we do all of this in all 50 states in the U.S., as well as bringing you access to a network of property management and real estate advisors after your exchange, and helping you create long-term investment strategies. When selecting a qualified intermediary, be sure to read customer reviews and testimonials and choose one that answers the phone when you call, no matter what time, and responds to emails within 24 hours. 1031 Pros is that qualified intermediary, and we are ready to help you with your exchange.
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How much does a 1031 improvement exchange cost?Pricing is determined on an individual basis, but at 1031 Pros we offer competitive prices and are willing to match anyone else’s offer.
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What are 1031 exchange services and how can they benefit me?Unlike traditional real estate transactions, where you sell one business or investment property and buy another – and pay heavy capital gains taxes along the way – 1031 exchanges let you defer capital gains taxes. When choosing what types of properties to include in your real estate portfolio, working with a Qualified Intermediary to ensure compliance with tax regulations and set a long-term investment strategy will help you grow your portfolio faster.
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Are there different types of 1031 exchange services?There are, based on when you sell your relinquished property and acquire a replacement property. We handle all types of exchanges, including in-kind, reverse, partial, and new construction exchanges.
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How do I choose the right service provider for a 1031 exchange?You want a Qualified Intermediary with extensive experience handling all types of 1031 exchanges, who is up on the latest regulations, who has a good reputation, and provides excellent and quick customer service. At 1031 Pros, we check all of these boxes and more.
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What are the common mistakes in 1031 exchanges and how can they be avoided?The biggest mistake is meeting deadlines: the 45 day timeline for identifying a replacement property and the 180 day timeline for completing the exchange. If you miss these deadlines, you are responsible for paying capital gains taxes on the sale of your relinquished property. Another mistake is not being in compliance with IRS regulations. At 1031 Pros, we will help you navigate the complexities of exchanges successfully.
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How long does a 1031 exchange take from start to finish?This depends on the type of exchange. If you have already identified (or even acquired) a replacement property, then the process is quicker than if you are looking for a replacement property or undertaking construction or improvements on the new property. Call us at 916-252-6900 for a free consultation and, depending on the needs of your exchange, we will be able to advise you on what timeline to expect.
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How much does a 1031 exchange cost?Our 1031 exchange solutions are priced competitively with those of other 1031 exchange service providers, and we will match the price quote you receive from any other services – while bringing our world class, responsive customer service to your exchange.
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Can 1031 exchange services help with property outside the U.S.?We can handle 1031 exchanges of foreign property with like-kind property both at home or abroad. Call us at 916-252-6900 to learn more.
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What should I prepare before contacting a 1031 exchange service provider?If you have already acquired your replacement property, then you should come to the conversation with details on the new property. If you are undertaking new construction or improvements on a replacement property, then you should bring information on the property, planned improvements, and the details of any related construction loans. If your exchange is like-kind or partial, then you should bring information on the properties.
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How does a 1031 exchange apply to new construction projects?In some ways a New Construction 1031 Exchange is similar to other 1031 exchanges: the 180 day timeline, the importance of not owning both properties at the same time, and compliance with all IRS regulations. However, with new construction there are other steps in the process, such as working with a Qualified Intermediary like 1031 Pros to set up a special purpose entity and pay for improvements. Contact us at 916-252-6900 with any questions or to get the process started.
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What are the time constraints in new construction 1031 exchanges?45 days to identify your replacement party, and 180 days for the acquisition to be finalized.
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Can I manage the construction process myself in a 1031 exchange?Yes, you or an appropriate representative will serve as the project manager on the construction process, working with us as your Exchange Accommodation Titleholder (EAT) to pay vendors using exchange funds.
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What are the risks involved in new construction 1031 exchanges?Construction projects sometimes run past projected deadlines, exceed their allotted budgets, and experience market fluctuations during the life of the project. The experts at 1031 Pros will work with you to ensure that you are set up for success.
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How do I select a qualified intermediary for a construction-focused 1031 exchange?You should choose a Qualified Intermediary with deep expertise on 1031 exchange regulations, particularly those that are new construction or improvement projects. You also want a partner who is available to answer questions at any time. At 1031 Pros, we always answer the phone when you call and are ready to help you know what you need to know, and what you need to do next.
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How much does a new construction 1031 exchange cost?Pricing is determined on an individual basis, but at 1031 Pros we offer competitive prices and are willing to match anyone else’s offer.
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What exactly does a qualified intermediary do in a 1031 exchange?They will carefully and accurately prepare the exchange agreement, assist with writing contracts, set up an individual secure account for each exchange, coordinate all transactions, work with legal advisors and title companies, report to you regularly, and prepare all of the tax documents you need to avoid paying capital gains taxes.
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How do I choose a qualified intermediary for my exchange?You want to find a qualified intermediary with experience in the particular kind of 1031 exchange you need. You also want to make certain that they have experience in the state where your exchange will take place. At 1031 Pros, we are that QI, and then we go farther – providing you access to a network of property management and real estate advisors after your exchange and helping you create long-term investment strategies. We are also proud of our highly responsive and helpful customer service; we answer the phone when you call, anytime day or night, and respond to emails within 24 hours.
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What are the key qualifications a good intermediary should have?They should be an expert advisor on the different options you have when it comes to 1031 exchanges, and then experience in the type of 1031 exchange that you want to undertake. They should be appropriately licensed, fully bonded, insured, and a member of the Federation of Exchange Accommodators. They should also operate with the highest ethical standards to protect your funds in an individual, unique account, and be committed to fast, responsive, and accurate customer service.
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What are any risks involved in using a qualified intermediary?The risks come with not using a qualified intermediary who is deeply experienced in the relevant type of 1031 exchanges, who are not meticulously detailed when it comes to every transaction, and who do not coordinate and communicate with all parties involved in order to make sure that your exchange is successful.
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How can I ensure my funds are secure with a qualified intermediary?Your QI should always deposit any funds from an exchange into a separate and unique FDIC-insured account, secured with dual signature requirements. They should also be transparent when it comes to reporting and adhere to strict ethical standards regarding handling funds.
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What should I expect from my intermediary during the exchange process?You should expect for your QI to come to the table with expertise in 1031 exchanges, to be highly responsive to any questions and even proactively communicative with you and other parties, and to deliver all documentation, thoroughly prepared, at the right times. At 1031 Pros, we are ready to help you with your exchange, no matter what type you need to undertake. Call us at 916-252-6900 for a free consultation and to get started.