New Construction in Exchanges

Saturday, October 17th, 2009

New Construction as  Replacement Property

Can new construction be counted toward the replacement property in a tax deferred Section 1031 exchange?  The answer is no!

But real property with newly constructed “built to suit” buildings or other improvements in place can be if the exchange and the construction are properly arranged and the improved property deeded to the exchangor within the time limits for a 1031 exchange.

Question:  I want to exchange my existing rental property in New York for a rental property in Florida, but I can’t find a suitable property to acquire.  I found a builder who can build what I want and a site that I can acquire.  Can I build on the lot to complete an exchange?

Answer: No, you can’t!  But if a qualified intermediary acts for you in your 1031 exchange it can take the proceeds from its disposition of your old property and use a single purpose Florida limited liability company to contract with the contractor to build the designated improvements, hold title while the  construction is permitted and completed, and then deed the then improved real property to you to complete the 1031 exchange.

Rules to Apply

1.       If you exchanged away real property only real property qualifies as like kind property. A contract to build, an intention to build, even a prepayment of cash to the contractor to build does not qualify as like kind property.  The improvements  constructed on the land at the time it is deeded to you do qualify as real property and like kind.

2.       If you receive title to the land before the improvements are in place, only the value of the land is like kind replacement property.

3.  The title must be deeded to you with the new construction on it within 180 days after closing the property exchanged away in order to apply any amount as replacement property.  Nothing constructed on the property after the deeding to you qualifies as replacement property.

4.  To defer all accrued gain on the property exchanged away, the value of the replacement property must equal or exceed the sale price of the relinquished property and all the cash proceeds must be placed into the replacement property.

There are problems:

a.)  I have cash but it takes more than 180 days to obtain approvals and permits and build the improvements. Structure the disposition of your old property for a delayed closing.  The 180 days is not flexible.

b.)  I have a mortgage on my New York property.  The sale won’t provide enough proceeds to fund acquisition of the land and construction of the improvements. You can’t mortgage property you don’t own and you cannot own the replacement property while the construction is being done and count the value of the construction as replacement property.  Call your tax attorney.

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