Imagine being able to sell your appreciated property with all of its gains intact, reinvesting in a new property, and having a budget for improvements, all while enjoying the capital growth of that new property immediately. Guess what? There is an exchange method for that!
Here is the Issue
Under the IRS rules, once you take ownership of a property, any additional expenditures used to make improvements to the property cannot count towards the value of the replacement property in the exchange.
An example of this problem: say that you’re selling building A for $1m and buying building B for $800k. But Building B requires $200k in desired improvements. In a traditional exchange this is a nonstarter; because real estate exchanges have to involve disposing of and acquiring “like-kind” real estate. And unfortunately, the additional labor and materials are not considered “like-kind” for the purposes of the acquisition and cannot be part of the exchange. So the $200k in required improvements cannot be part of the transaction.
However…
If an InSight client prefers a situation where they need to relinquish property and desires to renovate the next property, there is a path to eliminating the tax loss of the investment AND getting your renovations done.
Enter the Improvement Exchange
An essential, but overlooked part of the IRS code, can help InSight clients keep their expectations of avoiding a tax loss while making desired improvements a reality. This accommodation can be used to develop the right exchange strategy for the transaction that the business or person requires. If you need to contract out for repairs or improvements, make strategic accommodations for a renter, or change the opportunity completely – this method creates the space to achieve those changes to the property.
Under the IRS code in Revenue Procedure 2000-37, an independent third party may take title to the replacement property in the taxpayer’s stead and make the desired improvements on the taxpayer’s behalf.
Using an Exchange Accommodation Titleholder (or EAT)
In a traditional exchange, the exchange company acts as a qualified intermediary or QI. This means they act as a third-party agent that is both an arms reach from the taxpayer and they help to coordinate the timeline and reporting requirements to make the exchange IRS compliant. If the taxpayer requires improvements the conditions can change. The exchange company can become an Exchange Accommodation Titleholder or EAT and modifications can be made before the Taxpayer takes ownership – making the desired improvements to the property before taking possession.
The EAT takes title to the new property and parks, or holds, that title until the earliest of the following:
- 180 days from when the relinquished property is sold
- The improvements are completed
- 180 days from when the replacement property was parked by the EAT
The InSight client can enter into a property improvement exchange with an EAT and direct the QI to send funds periodically to the EAT. Making the desired improvements based on the eventual owner’s instructions. Effectively making the building improvements now part of the acquired property after the close of property A and before taking possession of Property B. Seemingly
limitless contractors, consultants, and designers can be paid out by the EAT during this phase, and the owner walks into Building B on day one of ownership with the work done, ready for business and with the changes they envision.
In the End
The client’s old properties cost basis is rolled into the new property, no taxes are paid on the sale of property A – and property B has received the required improvements to enable it to serve the investor better going forward.
