Improvement / Build-to-Suit Exchange

An improvement exchange, also called a build-to-suit exchange, allows an exchanger to use Section 1031 proceeds not only to acquire replacement property but also to fund construction or renovation on that property before it is transferred into the exchanger's ownership. This structure is useful when the best available replacement property needs substantial work, such as a vacant industrial building in need of buildout, or a parcel of land requiring ground-up construction, and the investor wants the value of those improvements to count toward the exchange rather than being treated as a separate, non-qualifying expenditure after closing.

The mechanical challenge with an improvement exchange is that a taxpayer cannot use exchange funds to improve property they already own, since doing so would not involve acquiring like-kind property from an outside party. To solve this, an improvement exchange relies on the same Exchange Accommodation Titleholder safe harbor under Revenue Procedure 2000-37 used in reverse exchanges. The EAT acquires and holds title to the replacement property during the construction period, using exchange funds held in a qualified escrow account to pay contractors, materials suppliers, and permitting costs as the improvements are completed. Because the EAT technically owns the property during construction, the exchanger is acquiring property from a party other than themselves, which preserves the like-kind exchange treatment for the value of the finished improvements.

Timing is the most significant constraint on an improvement exchange. All construction that is meant to count toward the exchange value must be substantially complete, and title must transfer from the EAT to the exchanger, before the one hundred eighty day exchange period expires. Unlike a standard purchase, construction and renovation projects routinely take longer than one hundred eighty days, particularly for ground-up development, so improvement exchanges work best for smaller scope renovation projects, tenant improvement buildouts, or projects where a significant portion of the construction can realistically be completed within the deadline. Any improvements completed after title transfers to the exchanger do not count toward the exchange value, since at that point the exchanger owns the property outright and further work is simply a capital improvement funded with the exchanger's own money.

Investors in Columbus, OH pursuing an improvement exchange should have a realistic construction schedule, a general contractor under contract, and permitting in hand, or nearly in hand, before the relinquished property closes, since the forty-five day identification period and the overall one hundred eighty day deadline do not pause for permitting delays, weather, material shortages, or contractor scheduling conflicts. Coordinating the Qualified Intermediary, the Exchange Accommodation Titleholder, the general contractor, and the lender well in advance is essential to completing enough of the improvement work to meet the deadline.