B — November 8 - 21, 2013 — Financial Digest — Mid Atlantic Real Estate Journal
www.marejournal.com
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By Pamela A. Michaels, Asset Preservation, Inc. Getting Credit for improvements in a Section 1031 Exchange
F
requently, investors ask whether they can buy property and make im-
take title to the to be improved property and thereafter make improvements. Improvements made after the investor ac- quires title to the replacement property will not be consid- ered when determining the amount an investor has spent in the 1031 exchange. The 1991 Treasury Regulations and Rev. Proc. 2000-37 established parameters for improvement exchanges outlined below. In a delayed or forward ex- change, an investor is entitled to a maximum of 180 calendar days from the date of sale of the relinquished property to
acquire all replacement prop- erty and spend all of the funds required to defer all desired capital gain taxes. This is also the case when performing an improvement exchange. How- ever, all improvements do not need to be completed during this period. The final value of the replacement property is the combination of the original purchase price plus the capital improvements made to the property during the exchange period. In addition, in an improve- ment exchange, the property to be improved must be parked
with an Exchange Accom- modation Titleholder (“EAT”) established by the Qualified Intermediary. The EAT holds title to the replacement prop- erty during the exchange and while improvements are being made. A significant amount of structuring and documentation is involved in properly complet- ing an improvement exchange so the use of an experienced Qualified intermediary and the involvement of the investor’s legal and tax advisers is es- sential. Further, in an improvement exchange, the 180 calendar day
period runs from the earlier of the sale of the relinquished property or the parking of the replacement property with the EAT which occurs on the closing of the sale of such property by the investor as title is transferred to the EAT and not the investor. Thus, in structuring improvement exchanges, investors should be aware that any delay between the sale of the relinquished property and the purchase of the replacement property to be improved will reduce the 180 day period in which improvements can be made. Savvy investors will gener- ally ensure that their sale and purchase are relatively close in time or will first purchase the property to be improved and structure the exchange as a reverse improvement ex- change. Most savvy investors also ensure that all permits are in place before closing on the replacement property or they risk that there will be little or no time remaining in their 180 day period by the time permits are obtained. One final note is that investors performing an improvement exchange would be wise to obtain an architect’s or contractor’s certificate of completion at the end of the 180 day period and to take photographs of the stage of completion to substantiate what improvements weremade during the exchange in case of an audit. No credit is permit- ted for prepaid fees for work performed after the expiration of the 180 day period. While it is essential to en- gage a competent Qualified Intermediary to facilitate an improvement exchange, these types of exchanges can pro- vide significant tax benefits to investors. Improvement exchanges can be used for ground up improvements, re- furbishing facilities, complete gut renovations to residential or commercial property and for build to suit projects. With proper planning, improvement exchanges can result in signifi- cant tax savings. Pamela Michaels is an attorney and vice presi- dent of Asset Preservation, Inc. n As a “Qualified Intermediary” as defined in the Section 1031 regula- tions, Asset Preservation, Inc. is not able to provide legal or tax advice. Accordingly, you should review the details of your specific transaction with your own legal or tax advisor. Copyright, 2013.
provements to it as re- p l a c eme n t property in a Section 1031 e x c h a n g e . The answer i s “yes” as long as the exchange is
Pamela Michaels
properly structured from initia- tion and the regulations gov- erning improvement exchanges are followed. The regulations do not permit the investor to
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