Ever wondered if it’s possible to use a 1031 Exchange for new construction? The answer is yes! It can be done, but it requires careful planning and understanding of the process. The new construction project must be equal to or greater in value than the original investment property at the end of the construction and before the representative deeds it back to the original investor. In this case, the investor can buy land or property worth less than the relinquished asset if the property value corresponds at the end of the construction period.
Is a New Construction Eligible for a 1031 Exchange?
In straightforward terms, yes. You can use a 1031 exchange for new construction. However, the process is quite intricate. A 1031 tax deferral can be used for a variety of transfers involving investment properties. Generally, the IRS forbids using money from a 1031 exchange for new construction projects or building ventures. They do, however, have rules that make it possible.
The requirements for a 1031 exchange with new construction are complicated and take a variety of things into account. With a straightforward 1031 exchange, the transaction proceeds can be utilized to buy a new property. According to IRS standards, taxpayers may postpone paying capital gains taxes under certain conditions.
How Does a 1031 Exchange on a New Construction Work?
Use a construction or improvement exchange. You can construct new buildings or repair existing ones on new replacement property that you bought via your 1031 exchange. This method is excellent for confirming that your replacement property has sufficient value while abiding by the IRS’s regulations for 1031 properties.
You can make renovations and additions to a home utilizing a 1031 construction exchange rather than paying for them out of the proceeds of the sale. The snag is that your authorized mediator will need to set up an Exchange Accommodation Titleholder (EAT) to retain ownership on your behalf rather than you doing so directly.
The fact that a different individual from the taxpayer or exchanger holds the rights to the new construction property is what matters most.
During the exchange process, the exchanger must name an impartial representative. The representative may be an Exchange Accommodation Titleholder or Qualified Intermediary. The person who receives the title will be designated in the Purchase Agreement.
The exchanger’s contractor can also purchase the site where the new structure will be erected.
When the deal closes, the EAT or intermediary will receive the title. The investor will establish an escrow account to hold all of the money related to the title. While taxpayers provide recommendations for construction, the titleholder covers the bills from the funds in the escrow account.
During the 180-day exchange phase (or until construction is finished), the appointed representative is the legal owner of the property. When a relinquished property is sold, the IRS distributes funds to purchase a new one.
It takes 45 days from the sale date to choose the replacement investment, just like other 1031 exchange transactions.
Every new construction serves as a replacement property, and specifics like building blueprints must be included in the description. When the building is ready, the representative will give the investor the title and use the new property in a standard 1031 exchange.
Deadlines for 1031 Exchanges on a New Construction
Based on the structure you have decided to use for your 1031 exchange, the timeframes to finalize the exchange on your new construction are the same as those for a Forward or Reverse 1031 Exchange. There are no differences between the 45-day and 180-day deadlines. You have 45 days to find the right property depending on the structure. You then have an additional 135 days, for a total of 180 calendar days, to finalize a 1031 exchange on your new construction.
Forward vs. Reverse Construction 1031 Exchanges
A construction 1031 exchange may take place either forward or reverse. Both deals are still subject to the 45-day and 180-day time constraints. Whatever combination method you decide on, the construction 1031 exchange enables you to buy your replacement property and utilize some of the proceeds from the exchange to make tax-deferred improvements to it, as long as the proper parking structure has been installed.
Forward Construction 1031 Exchange
Organizing forward 1031 exchange deals to benefit from a construction 1031 exchange is possible. This integrated 1031 exchange plan enables you to find and buy replacement property and implement modifications to your replacement property as part of the 1031 exchange process after first selling your relinquished property. A forward exchange involves the sale of the replacement property first, using the sale proceeds for building or improvements, and then purchasing the replacement property.
The selection, upgrades, and actual closing on the replacement property must be completed within the specified 1031 exchange time frames.
Reverse Construction 1031 Exchange
It is also possible to create reverse 1031 exchange deals to benefit from a construction 1031 exchange. This approach enables you to buy your replacement property while simultaneously making improvements to the newly acquired and attempting to sell your current relinquished property. In a reverse 1031 exchange, the replacement property is purchased initially and upgraded while the relinquished property is sold.
Completing the improvements to the replacement property and the handover of the finalized modifications from the Exchange Accommodation Titleholder to you must occur concurrently with the finalization of your relinquished property’s sale for the 1031 exchange to be completed according to the established timelines.
Costs and Fees for Construction Exchange
Because construction 1031 exchanges are much more complex and expensive, you should evaluate the amount of deferred capital gain tax obligations and depreciation recapture to ensure the cost of the 1031 exchange process is fair.
With an improvement exchange, real estate investors may create the ideal replacement property to get precisely what they want. Enhancements can range in complexity from straightforward repairs to extensive new construction.
FAQs
Who is the exchange accommodation titleholder?
The Exchange Accommodation Titleholder is a third party who retains ownership rights to the replacement or relinquished property throughout the reverse exchange process until the relinquished property gets sold.
What if I close on the replacement property before construction is complete?
The remaining construction might be referred to as “boot” if you close on your new triple net lease property before it has been completed. In this context, “boot” refers to money or other assets added to the transferred products’ values to make them equal.
The IRS does not regard the boot as like-kind property in a 1031 exchange. As a result, the base amount’s capital gains are tax-deferred. However, the yield on the boot is now taxable.
Can I obtain the property title after purchasing the land?
Since the land and building are legally recognized as one entity, you can only acquire ownership of the property if construction has begun on the building, even though you own the land. In this scenario, the 1031 exchange would be unlawful.
Final Thoughts
For those wondering “can a 1031 exchange be used for new construction?”, the answer is yes! By investing in new property using a 1031 exchange, you profit from a new facility with often minimal upkeep and consistent monthly revenue for the NNN lease, in addition to receiving similar capital gains tax deferral.
To kickstart a smooth process for your 1031 exchange transaction, we advise you to work with a NNN Deal Finder Advisor before or during the sale of your original property.
Every second counts when it concerns new construction. Taking action right away will help us finalize the deal within the allotted 180 days and help you defer capital gains taxes.