AN EXCHANGE THAT MORPHED INTO AN IMPROVEMENT EXCHANGE
David had sold the farm that he had owned for many, many years and
realized a capital gain of $800,000. With that money, he entered into a
Section 1031 tax-deferred exchange with us and went out to find his new
property. His intention was to find an apartment building that would
provide a nice income.
What he found was a property that he could purchase for $650,000,
which left him with $150,000 on which he would owe taxes to both the
federal government and the state in which he lived. At that point, he
considered trying to find another property such as a duplex or a nice
single family home. After discussing the situation with us, we jointly
reached a different conclusion. The property he had agreed to purchase
for $650,000 could benefit from new windows, new siding, and a new roof,
which would use up the remaining $150,000 in David's exchange account.
In order to include the improvements in the exchange, we set up an
Exchange Accommodation Titleholder ("EAT") to hold title to the new
property during the course of the improvements. An EAT is an LLC that
exists for the sole purpose of holding title to such a property so that
the closing that would transfer title to the exchanger (David, in this
case) can be delayed. Once the improvements were completed, a closing to
transfer title of the new property from the EAT to David was
accomplished and David had successfully used all of his exchange funds
in the new property.
The timing requirements of an exchange state that the entire exchange
must be completed within 180 days. This requirement applies to an
improvement exchange as well. The 180 days allowed starts from the date
that the relinquished property closes, so in some cases this can create
some complications. However, with proper advance planning, morphing your
exchange into an improvement exchange can salvage the complete tax
deferral that might otherwise not be available.