The Build-To-Suit Exchange
The build-to-suit exchange, also referred to as a construction or improvement exchange, gives the Exchanger the opportunity to use all or part of the exchange funds for construction of the replacement property and still accomplish a tax deferred exchange. This is a variation of the delayed or reverse exchange that allows the Exchanger more flexibility and provides the Exchanger with the opportunity to either renovate an existing improved property or even construct a new improvement on raw land. In the most common type of build-to-suit exchange the Exchanger sells the relinquished property in a delayed exchange and then acquires the replacement property after it has been improved with the exchange funds from the relinquished property. It is important to note that any improvements made to the replacement property after the Exchanger takes title are considered to be “goods and services”. These goods and services are not considered “like-kind” property and are taxable as boot as are any remaining exchange funds. Treasury Regulations §1.1031(k)-1(e). Consequently, to be included in the exchange any improvements to the property must occur before the Exchanger takes title. Bloomington Coca Cola Bottling Co. v. Commissioner, 189 F.2d 14 (CA7 1951).

If the Exchanger wishes to include construction on the replacement property as part of the exchange, one option is to contract with the seller to have the construction completed by the seller or a contractor before the transaction closes and the Exchanger takes title to the property. Escrow holdback accounts do not work for build-to-suit exchanges. Another option for the Exchanger is to negotiate with a builder to purchase the replacement property for the purpose of completing the construction, and then when the replacement property is finished the Exchanger can sell the relinquished property in an exchange and buy the improved property from the builder to complete the exchange. If neither of these options will work, or when the Exchanger desires to structure the transaction under the “safe harbor” guidelines of Revenue Procedure 2000-37 (“Rev. Proc. 2000-37”) as discussed below, the build-to-suit exchange is accomplished by using an Exchange Accommodation Titleholder to hold title to the Exchanger’s replacement property pending the completion of the improvements. In all cases it is important to remember that all applicable rules of IRC §1031 apply equally to build-to-suit exchanges, such that the Exchanger has 45 days to properly identify the replacement property, and no more than 180 days to acquire the identified improved replacement property. Also, to have a totally tax deferred exchange, the Exchanger must ultimately acquire replacement property that is of the same or greater value as the relinquished property, and use all of the exchange equity in the acquisition price of the replacement property and the construction of the improvements.

Until recently it had been unclear whether the validity and nonrecognition status of the build-to-suit exchange would be upheld by the IRS if the replacement property that was to be improved was acquired by either the Qualified Intermediary or an entity created by the Qualified Intermediary to park the property pending the construction of the improvements. However, that question was answered by the IRS in the form of Rev. Proc. 2000-37, which provides that nonrecognition treatment on exchanges in which either the replacement property or relinquished property is parked with an exchange accommodation titleholder pursuant to the terms of the Revenue Procedure will be recognized if the transaction falls within the scope of this announced IRC § 1031 “safe harbor.”