Generally, no, you can not sell real property ("relinquished property") and defer the payment of your depreciation recapture and capital gain income taxes by structuring a 1031 exchange by building on real property that you already own or by paying off the mortgage on the property. Building on property that you already own or the pay off of your outstanding mortgage loan is not considered an acquisition of real property ("replacement property"). You must purchase a new interest in real estate as your like-kind replacement property in order for it to qualify for tax-deferred exchange treatment under Section 1031 of the Internal Revenue Code.
However, it might be possible to create a new, separate real property interest that did not previously exist that you could acquire as your like-kind replacement property using the property that you already own.
The following quick facts will help you understand the chain of events necessary to structure this advanced build-to-suit 1031 exchange strategy in order to comply with the applicable Private Letter Rulings and Revenue Procedure issued by the Internal Revenue Service.
Complete copies of all Private Letter Rulings and Revenue Procedures.
1031 Exchange with Qualified Intermediary
Qualified Intermediary assigns into relinquished property sale transaction.
Relinquished property sale transaction closes and 45 and 180 day deadlines begin.
1031 exchange equity (net proceeds) wired to and held by Qualified Intermediary.
Investor identifies the like-kind replacement property consisting of the 30 plus year lease and improvements during the 45 calendar day identification period.
Qualified Intermediary is assigned into the Qualified Exchange Accommodation Agreement (QEAA) between the EAT and Investor to acquire the like-kind replacement property consisting of the 30 plus year lease and improvements.
Qualified Intermediary uses the 1031 exchange equity to acquire the like-kind replacement property consisting of the 30 plus year lease and improvements from EAT.
Qualified Intermediary will direct the EAT to assign the ownership interest in Titleholder directly to Investor to transfer title of the 30 plus year lease plus improvements and complete the 1031 exchange.
Build-To-Suit with Parking Arrangement Pursuant to Revenue Procedure 2000-37
Investor creates a new entity, which is typically a limited liability company (LLC) with a majority interest owned by Investor and a minority interest own by another party (can be a related party).
Investor then conveys the real property to be improved into the new entity.
Ideally would like to have some kind of holding period before beginning construction and proceeding with the parking arrangement.
Exchange Accommodation Titleholder (EAT) then forms a single-member limited liability company (Titleholder) to hold title to the like-kind replacement property discussed below.
LLC leases real property to Titleholder owned by EAT under a 30 plus year lease at fair market rental rates.
Execution of the 30 plus year lease “creates” a new real property interest that did not previously exist.
Investor identifies relinquished property within 45 calendar days of the Titleholder entering into said lease.
Investor advances funds and/or arranges third-party financing to the EAT to cover construction costs (these are separate funds from the 1031 exchange equity held by the Qualified Intermediary).
In most cases, the 1031 exchange with the Qualified Intermediary and the advanced build-to-suit parking arrangement are progressing simultaneously.
In a nut shell, you will have disposed of (sold) your relinquished property to a third-party buyer and acquired a like-kind replacement property in the form of a new real property interest consisting of a 30 plus year lease with improvements that is held in a singe-member limited liability company (Titleholder). The related party entity (LLC) continues to own the initial real property that is being leased to the Titleholder, and Titleholder will continue to lease the property from the LLC.
Titleholder will enter into Construction Management Agreement with LLC and will arrange for real property to be improved thereby increasing the value of the 30 plus year lease with the value of the improvements.
Once the improvements have been completed, but in no event later than the 180 calendar day deadline, the following events will complete the transaction:
Investor will transfer and assign its rights under the QEAA to the Qualified Intermediary.
Qualified Intermediary will direct the EAT to transfer the like-kind replacement property directly to Investor by assigning the ownership interest in Titleholder to the Investor.
Qualified Intermediary funds this acquisition by transferring the 1031 exchange equity to EAT.
EAT uses the 1031 exchange equity to pay Construction Manager for construction, services, and costs and repays any funds advanced by Investor and/or any loans used to fund construction.