Improvement Build-to-Suit Exchange

An improvement exchange, sometimes called a build-to-suit exchange or a construction exchange, allows an investor to use 1031 exchange funds not only to purchase a replacement property but also to fund construction or renovation on that property, with the improved value counting toward the total value needed to fully defer gain. This structure is particularly useful in the Jacksonville market when the best available replacement property needs work before it matches the value or functionality of the relinquished property, or when an investor wants to build a purpose-built asset, such as a single tenant net lease building constructed for a specific operator, rather than buying an existing structure.

The mechanics rely on the same Exchange Accommodation Titleholder safe harbor used in reverse exchanges, described in Revenue Procedure 2000-37. Because exchange funds generally cannot be used to improve property the investor already owns directly during the exchange period, the EAT takes and holds title to the replacement property while construction or renovation proceeds. Exchange funds held by the Qualified Intermediary are used to pay for the improvements, and once construction is complete, or once the one hundred eighty day exchange period ends, whichever comes first, title to the improved property transfers from the EAT to the investor to complete the exchange.

Timing is the central constraint of an improvement exchange, and it is stricter than many investors initially expect. All identification and closing deadlines that apply to a standard exchange still apply. The replacement property must be identified within forty-five days if it was not already under EAT ownership at the time the relinquished property closed, and the entire structure, including as much of the construction as the investor wants credited toward the exchange value, must be completed within one hundred eighty calendar days. Only the value of improvements actually completed and in place by day one hundred eighty counts toward satisfying the exchange. Construction that is only partially finished by that date still transfers to the investor, but the uncompleted portion does not receive exchange treatment, which can create unexpected boot if the total improved value falls short of the relinquished property's value.

Because of this hard stop, improvement exchanges require a realistic construction schedule established before the relinquished property even closes. A one hundred eighty day window is workable for tenant improvements, interior renovations, or smaller ground-up projects, but it is generally too short for large ground-up commercial construction with lengthy permitting and site work, which is a real consideration in parts of the Jacksonville metro where site development, utility extension, or environmental review can extend timelines. Investors considering an improvement exchange for property in growth areas such as Nocatee, the Southside, or industrial sites near Cecil Commerce Center need to weigh whether the intended scope of work can realistically be substantially complete within the exchange window.

Improvement exchanges also carry additional cost and complexity compared to a standard exchange, since the EAT structure requires its own financing arrangements, insurance, and construction draw administration coordinated through the Qualified Intermediary. Lenders need to be comfortable financing construction on property held by an accommodation entity rather than by the investor directly, which is not something every commercial lender offers.

We help Jacksonville-area investors evaluate whether an improvement exchange timeline is realistic for a given scope of work, coordinate the Exchange Accommodation Titleholder and construction draw process with the Qualified Intermediary, and build a schedule that maximizes the improved value credited toward the exchange before the one hundred eighty day deadline arrives.

Permitting timelines deserve special attention when evaluating an improvement exchange in the Jacksonville area, since permit review and inspection scheduling with the local building department can add weeks to a project that would otherwise move quickly. An investor planning tenant improvements to a medical office condominium, for example, needs to account for permit review time, inspection scheduling, and any code compliance work in addition to the physical construction schedule when estimating whether the project can be substantially complete within one hundred eighty days. Building in buffer time for permitting delays, rather than assuming construction can begin the day the EAT takes title, is one of the most common gaps in improvement exchange planning.

Selecting a contractor for an improvement exchange also carries different considerations than a typical renovation project, because draws are administered through the Qualified Intermediary rather than paid directly by the investor as work is completed. Contractors need to be comfortable with a draw schedule tied to the exchange structure, and the Qualified Intermediary typically requires documentation, such as invoices, lien waivers, and inspection sign-offs, before releasing funds for each draw. Investors should confirm their contractor has experience with this type of payment structure, or budget extra time for the contractor's team to adjust to it, before the construction schedule is finalized.

Investors sometimes ask whether personal property installed during the improvement, such as fixtures, appliances, or equipment, can be paid for with exchange funds and counted toward the exchange value. Generally, only amounts spent on real property improvements, meaning items that become a permanent part of the real estate, count toward the like-kind exchange value. Personal property purchased and installed as part of the same project is typically treated separately and does not receive exchange treatment, which is another reason a clear scope of work, reviewed against the Section 1031 rules before construction begins, helps avoid an unexpected tax outcome at the end of the exchange period.