Oftentimes investors wish to acquire property that requires improvements, such as a new roof, major remodeling, or any number of other things. One way that investors can satisfy those desires is through the use of an Improvement Exchange.

1031 improvement exchange

Some people use the term "Improvement Exchange" interchangeably with "Construction Exchange" and "Build-to-Suit Exchange." Although they are structured similarly, we prefer to use the term "Improvement Exchange" when improvements are to be made to an existing structure or property.

A simplified example: an investor sells relinquished property with a value of $400,000 and debt of $150,000. In order to fully defer any tax liability, he must acquire replacement property with a value of at least $400,000 and invest his entire equity of $250,000 in the new property.  Let's assume he finds a distressed property worth $300,000 that needs $100,000 worth of improvements. By acquiring the property within an improvement exchange, he can pay for those improvements with exchange funds.

Structuring an Improvement Exchange

Any improvements made after the investor takes title to the property cannot be made from exchange funds, so a workaround solution must be employed. The workaround comes from the rules for a Reverse Exchange and requires Iowa Equity Exchange to establish an "Exchange Accommodation Titleholder," or "EAT," to hold title to the property during the improvement phase. During that phase, the investor makes all of the construction decisions, either functioning as the general contractor himself or hiring the GC of his choosing. After improvements are completed (and before the expiration of the 180 days exchange period), the exchange is completed by the investor buying the improved property from the EAT.

Pros and Cons of an Improvement Exchange

Obviously, the primary advantage to an improvement exchange is the ability to purchase property and use exchange funds for necessary improvements. Doing so can sometimes result in a boost in equity in the new property for the investor. Other than the 180-day time frame required for virtually any exchange, the main drawback to an improvement exchange is that there are additional costs associated with this type of structure. The tax deferral is often more than enough to make these additional costs inconsequential.

Even more so than with typical exchanges, it is important to contact Iowa Equity Exchange to discuss your particular plans and situation. We can help you determine whether an improvement exchange will be beneficial to you, and it costs nothing to consult us.