What you need to know about Improvement Exchanges...

In an improvement exchange, the owner typically wants to repair or renovate an existing building or construct a new building on vacant land on the replacement or relinquished property, with those improvements counting toward the exchange value.

The effect of recent construction or other improvements on relinquished property is unclear. Most often, the owner wants to make improvements to the replacement property while it is held in escrow, but this may potentially cause constructive receipt issues or otherwise jeopardize qualification under the safe harbor provisions.

To fill this gap, a QI or EAT that owns the replacement property can generally make improvements to it during the 180-day exchange period before transferring title to the Purchaser (Rev. Proc. 2000-37). The Purchaser generally cannot be both the transferee and transferor in an improvement exchange (see Rev. Proc. 2004-51).

The procedure for conducting an improvement exchange is similar to conducting a reverse exchange and is outlined in Rev. Proc. 2000-37. In the structure chart below, the Purchaser is conducting a 1031 improvement exchange.

Although the steps involved in an improvement exchange may vary, they typically follow a similar pattern:

•       Step 1: The Purchaser and Seller enter into a purchase and sale agreement (PSA) for the replacement property. The PSA is assigned to the EAT so the EAT can hold title to the replacement property until a purchaser for the relinquished property is found.

•       Step 2: The Seller transfers the replacement property to the EAT.

•       Step 3: Within five days of the transfer of the replacement property, the Purchaser and the EAT must enter into a Qualified Exchange Accommodation Agreement (QEAA), that states the following:

•       the EAT is the beneficial owner of the replacement property on behalf of the Purchaser to complete a 1031 exchange under Rev. Proc. 2000-37;

•       the parties will report the acquisition, holding, and sale of the replacement property as required under Rev. Proc. 2000-37; and

•       the Purchaser and the EAT will treat the EAT as the beneficial owner of the property for federal income tax purposes.

•       Step 4: Within 180 days of the transfer of the replacement property to the EAT, the Purchaser transfers the relinquished property to the Third-Party Purchaser.

•       Step 5: The EAT constructs improvements, repairs, or renovations during the exchange period and then transfers the replacement property to the Purchaser.


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The contents herein are intended to convey general information only and not to provide legal or tax advice.  You are advised to contact your legal or tax advisor for specific advice on 1031 exchanges.  No action should be taken in reliance on the information contained herein and we disclaim all liability in respect to actions taken or not taken based on any or all of the contents herein to the fullest extent permitted by law.