Many real estate investor are aware of the money saving power of a 1031 exchange, and how it allows one to transfer their captial gains taxes from the sale of a property, into another like-kind property. But it isn’t possible to use the money from your exchange to pay the debt on an investment property that you already own – and likewise, you can’t build improvements on land that you own with a 1031 exchange.One common pitfall for inexperienced investors is attempting to make improvements on land that they already own, but this does not qualify for 1031 status.

The 1031 exchage proceeds would ideally be used to make the build to suit to your specifications on the new land, i.e., you secure the desired property and buy another investment property that is equal to or greater than in value. So how does one accomplish this?

There is an option called “the poor man’s build to suit exchange” wherein the buyer requests that the seller make the desired improvements to the structure prior to the completion of the sale. An investor, for example, sells an investment property worth 0,000 and intends to buy a replacement property worth the same (or greater).Although the vacant land she wants to buy is worth only ten-thousand dollars, which doesn’t fully qualify for a “like-kind” exchange, thus making an exchange impossible.

In this scenario, the investor would ask the replacement property seller to increase the sales price to 100 thousand dollars, and before closing, the seller will have to construct 90 thousand dollars worth of improvements to the property. In the end, she will be purchasing property of equal value (100 thousand dollars).

Finding a replacement property seller who is willing to increase the sales price, and make improvements before closing, may be difficult.  Alternately, in our investors case, she can have her QI purchase the investment property on her behalf for k (using an LLC that the Qualified Intermediary owns outright) then construct the improvements to the property using the remaining funds from the exchange.

Put another way, your qualified intermediary will hold the property during it’s improvement process, funding them with the money from the exchange. The investor will receive the property from the QI when the improvements are completed on the replacement property, thereby completing the exchange.

Keep the following points to in mind about the 1031 Build to Suit exchange. 1st, the 180 day period that is allotted to you to complete your exchange, won’t give you adequate time for a complex build to suit.  However, it should be enough time to rehabilitate or remodel an existing structure.

Secondarily, to be considered an actual “like kind” exchange, any of the improvements to the replacement property must constitute “real-estate”, i.e., real estate for real estate. Just dumping the building supplies on the location of your property won’t be enough, to constitute “real estate” those materials must be made a permanent part of the structure or affixed into the land.

Keeping your savings in mind, be careful to stay away from any potential problems, to get the money saving tax benefits of a build to suit exchange.

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