Structures
Improvement Exchanges: Spending the Difference
When the replacement costs less than what you sold, an improvement exchange lets construction absorb the gap instead of the IRS.
Illustration generated for this article by 1031 Exchange News Today.
An improvement exchange solves a narrow but common problem: the replacement property you want costs less than the one you sold, and the difference would be taxable boot. Instead of handing that gap to the IRS, you spend it on the building.
The problem it solves
Sell for $1,400,000, find a replacement at $1,100,000, and you are $300,000 short. That $300,000 is boot and it is taxable now. But if you spend $300,000 improving the replacement before the exchange completes, the improved property is worth $1,400,000 and the gap closes.
It also works when the right property is a teardown, a shell, or land you intend to build on.
How it is structured
The same accommodation titleholder used in a reverse exchange takes title to the replacement property. Exchange funds pay for the construction while the entity owns the property, and title transfers to you at the end with the improvements already in place.
What 180 days buys you in construction
Not much, and this is the honest constraint on the structure. Six months from acquisition to substantially complete is achievable for renovation, tenant improvements, roofing, systems replacement and site work. It is not achievable for ground-up construction of anything substantial.
| Scope | Fits in 180 days? | Notes |
|---|---|---|
| Cosmetic renovation | Comfortably | The most common use of the structure. |
| Systems and roof replacement | Usually | Permitting is the variable, not the work. |
| Tenant improvements | Usually | Depends on the tenant's own schedule. |
| Major structural work | Rarely | Permitting alone can consume the window. |
| Ground-up construction | Almost never | Only viable on small, pre-permitted builds. |
What it costs
The same band as a reverse exchange, $5,000 to $10,000 and up as a market range, plus the administration of construction draws. You are paying for the same accommodation entity, plus somebody disbursing funds against invoices and keeping the record the IRS will want.
Getting permits before you start the clock
The single biggest determinant of whether an improvement exchange completes is whether permitting was underway before day one. Investors who identify a property, then begin the permitting conversation, generally run out of window.
Disclosure
This article is published by Easy1031, a qualified intermediary with a commercial interest in readers starting an exchange. The rules and mechanics described here are the same whichever intermediary you use. Nothing here is tax or legal advice.
