An important fact in regard to the 1031 process is that you CANNOT use your 1031 proceeds to fund improvements on land you own already. This is a common stumbling block of inexperienced investors. In order to qualify for a capital gains tax deferral, the replacement property must be of LIKE KIND with the relinquished property. In this case, the property you purchase must comprise real estate with a value at least as high, if not greater than that of the relinquished property. An improvement that is incomplete is considered a contract for a service, comprising personal estate but not real property. Because a property purchased as a replacement in a 1031 exchange must be of like kind and equivalent value with the relinquished property upon closing, it is, at times, difficult for an investor to locate one that fulfills these requirements and also fulfills his or her personal specifications.

So, how can you get the property of your dreams out of a 1031 exchange? There are two main ways you can go about acquiring a build-to-suit property that fulfills your structural specifications and fulfills the accounting requirements necessary for a like-kind exchange under section 1031

The first possibility is to perform what is known as a 'poor man's Build-to-Suit,' in which you, as the purchaser, request that the seller make particular improvements on a piece of property to increase its value prior to closing on the sale. For example, if you sold a a piece of property with a value of $100,000, and you were looking at a replacement property valued at $10,000, the seller could construct $90,000 worth of improvements to raise the value of the piece of property. These finished renovations would constitute real estate. You would then be able to the piece of property for one hundred thousand dollars, complying with the requirement of equivalent value. Most sellers, however, will not be very eager to perform the improvements you requested so that you may make an exchange. This brings us to the second option.

In the other, likelier scenario a qualified intermediary who holds your money can buy the replacement property from the seller, taking title to the property in a limited liability company, intermediary-owned company. The intermediary would then use the remainder of the money to build the desired renovations on the piece of property. After construction is completed, the intermediary transfers the replacement property to you, which then allows you to complete the exchange process.

Returning to the previously mentioned ten thousand dollar replacement property: the intermediary would buy the property at the asking price and would construct the desired renovations using what is left of your money, returning the replacement property to you when the value of the property is sufficient to constitute a like kind exchange.

Although a build to suit exchange can go a long towards getting you the replacement property that you really want, it is important to take into consideration the span of time required for the renovations that you would like to build . You only have one hundred and eighty to complete an exchange, so it is important to be conscious of what can actually be completed in this period. Keep in mind that a renovation represents real estate when it is finished, so a work in progress doesn't add to the property's value. Although you might not be able to build renovations as extensive as you might want, 180 days is sufficient time to accomplish significant remodeling, and to bring your replacement property that much closer to the property of your dreams.