You can even defer capital gains taxes INDEFINITELY, as long as each time you sell a property, you funnel the money back into another property according to the rules for 1031 exchanges.
But what do you do if you’d really prefer to build a real estate investment property that’s perfectly suited for a specific business?
Can you still take advantage of 1031 exchanges? Well, the answer is a resounding yes, and in the following article, we’ll go over some of the rules of 1031 construction exchanges.
WHAT ARE 1031 CONSTRUCTION EXCHANGES?
1031 construction exchanges are 1031 exchanges with a twist: instead of taking the money from the sale of your property and investing it in a property that is already built, the money is used to purchase bare land and build a property of equal or higher value.
HOW MUCH TIME DO I HAVE TO COMPLETE THE EXCHANGE?
1031 construction exchanges are still 1031 exchanges; therefore, you still have only 180 days in order to equalize the property. Let’s say that you sold a property for $500,000. The cost of buying the raw land is $75,000, and constructing a new building on it costs $1,000,000.
By the 180th day, you will need to have spent $425,000 on construction in order for the exchange to be valid. Otherwise, the entire amount of $425,000 will be taxable as capital gains.
WHEN DOES CONSTRUCTION OF THE BUILDING NEED TO BE COMPLETED?
In order for the 1031 exchange to be valid, it’s not enough to have merely bought the materials needed for the project. All materials need to be installed – in other words, the materials that were bought need to have been used in construction, not just lying around at the site.
CAN I TAKE TITLE ON THE PROPERTY ONCE I’VE BOUGHT THE LAND?
You cannot take title on the land, even if construction hasn’t yet begun. If you do, the 1031 exchange will be invalid, and you will be liable for capital gains taxes for the full amount of the property minus what was paid for the raw land.
In order to avoid this, some investors choose to have the builder buy the land.
However, this can cause problems if the builder bankrupts, or fails to complete the targeted work on time, thereby necessitating a new builder. A better solution is to choose a 1031 intermediary, which is a neutral party that lets you make all the decisions, while they pay the bills. They accomplish this by creating an LLC (Limited Liability Company), which will hold the land, and the money from the exchange, in a special account.
At the end of 180 days, or until you reach your equalization target, the title is transferred to you, and you retain complete ownership of the income property.
Are you considering a 1031 construction exchange, or have you done one in the past? What type of property did you build? Let us know in the discussions over at Google+.