The QI takes title to and warehouses the Replacement Property to be improved or land where improvements will be constructed until:
- Improvements are completed, OR
- All intended funds are utilized, OR
- No later than several working days prior to the IRS mandated 180-day Exchange Period.
IRS Identification requirements:
Within 45 days of the close of the sale of the first Relinquished Property, the address of the target property to be improved (there can be several) plus a list of the improvements to be completed and approximate values for the work must be provided in writing to the QI. Work with and your tax advisors to develop a letter that clearly identifies substantially what you will purchase, which is what the IRS requires. If an undivided interest is being identified, for example 40% of the property not 100%, the QI can only utilize exchange funds to pay for 40% of the improvements.
The advantage of Improvement & Build-to-Suit Exchanges:
Using pre-tax dollars to improve property provides many advantages, not the least of which is an improved property likely worth more than what you have spent based upon value added by your oversite of the improvements.
Funds utilized to improve and operate the property within the 180-day exchange period reduce the amount of potentially taxable unused exchange proceeds (cash boot).
How does construction work within § 1031 guidelines?
Taxpayer oversees the improvements by serving as the QI’s property manager including but not limited to hiring a general contractor, architect, engineers, subcontractors, and causing materials to be purchased to facilitate construction.
Throughout an Improvement Exchange, taxpayer provides the QI with initialed (approved) invoices for payment utilizing exchange proceeds, taxpayer-provided funds or bank-loaned funds. Cash from taxpayer and bank-loaned funds offset Debt Relief.
Taxpayer initials on an invoice mean:
- The invoiced portion of work is complete and/or materials have been received
- Taxpayer has inspected the work and/or materials
- Taxpayer approves of the completed work and/or received materials and authorizes Amherst to make the payment
Expenses incurred in an Improvement Exchange:
- The QI’s improvement exchange fee in addition to the standard deferred exchange fees
- The cost of insuring the QI during its ownership for no more than 180 days
- The cost of an additional escrow:
- QI purchase of the property to be improved*
- QI sale of the improved property to taxpayer
When possible, a title binder is utilized to reduce fees in this 2nd escrow/transfer.
As the property owner, QI keeps clear records of expenses allocated as improvements which add to property value. Operating expenses paid during the QI’s ownership are allocated separately to avoid unnecessarily inflating property value upon which property taxes will be calculated.
Can a loan be secured by the property being improved?
Any loan secured by the warehoused property must be in the name of the
QI as owner and guaranteed by taxpayer.