Improvement 1031 Exchange Guide: Using Exchange Dollars to Build or Renovate

How it differs from a delayed exchange: the EAT owns the site while you build with borrowed exchange money

In a delayed exchange the QI buys a finished building; in an improvement exchange an EAT, usually a single-member LLC formed for the project, takes title to the land and holds it while construction runs, so that what you eventually receive is improved real estate rather than a pile of construction invoices. The QI advances your exchange funds to the EAT as a loan, the EAT pays the contractors, and by day 180 the EAT conveys land and improvements to you through the QI.

Rev. Proc. 2000-37 makes this workable: section 4.03(5) lets you manage the property, supervise the improvements or act as the contractor without breaking the safe harbor, and section 4.03(3) lets you lend the EAT the money. The EAT must not be you or a disqualified person, must hold title from acquisition to transfer, and must sign the qualified exchange accommodation agreement within five business days of taking title.

The forward version starts after your sale, with the EAT buying the land inside your 180-day exchange period; the reverse version has the EAT buy and start building before your sale, with the 180-day parking clock running from the EAT's acquisition. The reverse exchange guide covers that clock and the exchange types overview places both.

Identify the land and the building plan by day 45, then deliver substantially the same thing

Reg. §1.1031(k)-1(e)(2) requires the identification of property to be produced to include the legal description of the land and as much detail about the improvements as is practicable, delivered by day 45 like any identification. Attach the site plan, the specification summary and the budget, because §1.1031(k)-1(e)(3) says the property received is not substantially the same as identified if substantial changes are made to what was to be produced.

Use the spare slots: the three-property rule lets you name the improvement project plus two alternatives, and naming a DST as one of them means a permit delay or a lender's refusal in month four does not turn the whole exchange taxable. The DST backup strategy shows how to size that entry to the shortfall.

What counts toward value on day 180 and what does not

Only real property that exists when the EAT conveys it counts. Section 1.1031(k)-1(e)(4) treats production occurring after you receive the property as services rather than like-kind property, and Legal 1031's process notes put it plainly: the improvements must be affixed to real estate to count for balancing purposes.

• Counts: the land at its cost including acquisition expenses, plus improvements completed and paid for at transfer (1031 CORP's formulation).
• Does not count: materials delivered but not installed, contractor deposits and prepaid work, permits and design fees for work not yet built, and any construction after the deed to you.
• Unspent exchange funds: if you identified another replacement they can buy it; otherwise they return to you as boot (IPX1031: unfinished construction can result in taxable boot exposure).
• The property does not have to be finished on day 180, only conveyed; what is in place sets the value and you finish it with your own money afterward.

Worked example: selling for $2,000,000 and building a $3,000,000 warehouse

Hypothetical: your sale closes for $2,000,000 with a $1,300,000 gain. The EAT buys an $800,000 industrial parcel on day 30 and starts a $2,200,000 build with a twelve-month schedule. By day 180 the foundation, steel and roof are up, and $900,000 of work is completed, affixed and paid; the EAT conveys land and shell to you at $1,700,000 of exchange value.

You reinvested $300,000 less than you sold for, so $300,000 is boot, generally absorbed first by unrecaptured §1250 gain at up to 25% plus 3.8% NIIT, about $86,400 federal if all of it falls there. The remaining $1,000,000 of gain stays deferred and your basis in the new building carries over from the old one.

Four fixes, from cheapest to most involved: sequence the build so the shell reaches $1,200,000 by day 180; buy a $1,100,000 parcel instead; place the $300,000 into an identified DST before day 180; or run it as a reverse-improvement so the EAT buys the land and starts building before your sale, letting more of the structure exist by the day the 180-day parking clock ends.

Risks that sink improvement exchanges: delays, lenders, holding costs and your own land

The 180 days cannot be extended outside a federally declared disaster (Rev. Proc. 2018-58 postpones the QEAA periods as well as the forward ones), so every risk below is a risk of receiving less real property than planned. Confirm the structure with your CPA or attorney before the EAT signs the land contract.

• Construction delay: 1031 CORP's advice is to have all permits, the builder contract and financing in place so construction begins immediately after the EAT closes on the land.
• Lender consent: Legal 1031 notes third-party lenders must approve the EAT taking legal title, and a construction lender is lending to an LLC guaranteed by you under section 4.03(2).
• Double closing costs: duplicate title premiums, loan costs and transfer taxes on the EAT-to-you transfer (1031 CORP), plus EAT holding costs you bear.
• Your own land: Rev. Proc. 2004-51 excludes property you already own, citing DeCleene v. Commissioner and Bloomington Coca-Cola Bottling, and says related-party leasehold structures remain under study; a lease with 30 or more years to run is like-kind to a fee under Reg. §1.1031(a)-1(c)(2), but a ground lease from your own LLC needs tax counsel before you rely on it.
• Disqualified EAT: an EAT related to you, or your own attorney or broker from the past two years, is outside the safe harbor.

When to separate development from the exchange, or use a DST or direct-title solution instead

Separate them when the land alone cannot absorb most of the proceeds and the build runs past six months, when the construction lender will not lend to an EAT, or when the project is speculative enough that a taxable outcome on day 180 is a real possibility. Exchange into stabilized property first and develop with other capital, or split: land plus a DST for the balance.

Our offerings fit the split. A traditional DST absorbs whatever the land and completed work leave uncovered, a direct title security gives you a deeded interest without a build, and a cash-out DST covers a large loan payoff when the parcel is bought for cash; the investment types page compares them. We are a broker for those structures, not the EAT or the QI, so the improvement exchange itself runs through your intermediary.