Turning Lemons into Lemonade with the 1031 Exchange

Welcome to Part III of our exclusive 2014 Guide to Your Next 1031 Exchange will take you step-by-step to reap the rewards in time! In this quarter's guide we will discuss built-to-suit exchanges, or using all or part of 1031 exchange funds for construction, renovations or new improvements!

Among mobile home park investors, perhaps more than any other real estate asset, there is great appeal and great reward in investing in a property that has been neglected and needs work. Perhaps construction or improvements are underway at the time of the exchange, or perhaps you’ve got your own grand vision for the target replacement property. Either way, plans are in the works, but is funding? Introducing the “Built-To-Suit” 1031 Exchange. In this quarter’s article we will briefly cover important information and the four key-phases of this type of exchange.

Defined by 1031 exchange experts IPX1031, “the build-to-suit exchange, also referred to as a construction or improvement exchange, gives the Exchanger the opportunity to use all or part of the exchange funds for construction, renovations or new improvements to the Replacement Property.” No, that’s not a typo, and yes, you can use the funds from a 1031 exchange for this...if you do it right and on time, which means to qualify for inclusion in the exchange the improvements must take place before the exchanger takes title! Anything that occurs after title is taken is considered “goods and services” and is taxable as boot per Treas. Reg. §1.1031(k)-1(e). However, time limitations and all other rules of IRC §1031 apply also to built-to-suit exchanges, but thanks to Rev. Proc. 2000-37 of the code a “safe harbor” for structuring a build-to-suit exchange using an Exchange Accommodation Titleholder (“EAT”) to hold title to the Replacement Property pending completion of the improvements is made possible.

In order to take advantage of the “safe harbor” you must use a qualified intermediary such as IPX1031. IPX1031 explains the process as follows: “Prior to closing on the purchase of the Replacement Property, the Exchanger enters into a Qualified Exchange Accommodation Agreement (“QEAA”) with the EAT and assigns its rights in the purchase contract to the EAT. The EAT then acquires title to the Replacement Property. The qualified intermediary holds all parked properties in a separate special purpose holding entity (typically a single member LLC) for each exchange. The Exchanger or its designated representative is authorized by the EAT to act as its project manager to oversee all aspects of the construction. During the 180-day exchange period, the Exchanger, as project manager, sends construction invoices to the EAT for payment.”

To help understand the process better, we’ve included a detailed four-phase process chart, courtesy of IPX1031.

For a full copy of the entire 1031 Exchange Guide for all four quarters of 2014, please contact Stephanie at Stephanie@McAnuffGroup.com or MobileQuarterly@McAnuffGroup.com for back issues of Mobile Quarterly.