If you are an investor, you may be aware of the section 1031 exchange rule, and how it can be used to defer the capital gains taxes on the sale of an investment property, into a replacement property of equal or greater value. Nevertheless, you cannot use the money from a 1031 exchange to pay off a property that you already hold title to – or build improvements on any a piece of land that you have used in a tax exchange.Commissioning updates on land that you already hold title to doesn’t qualify as "like-kind", and can be problematic for uneducated investors.

The 1031 exchange proceeds would ideally be used to make the build to suit to your specifications on the new land, i.e., you secure the desired property and buy another investment property that is equal to or greater than in value. So how does one accomplish this?

There is an option that is referred to the "Poor Man’s" build to suit, in which the buyer asks the seller to make improvements to the replacement property before the close. An investor, for example, sells an investment property worth 0,000 and intends to buy a replacement property worth the same (or greater).  But the raw land she desires is only worth thousand dollars, which will obviously not completely qualify for a like-kind exchange and thus, no deferred tax gain.

In this scenario, the investor would ask the replacement property seller to increase the sales price to 100 thousand dollars, and before closing, the seller will have to construct 90 thousand dollars worth of improvements to the property. In the end, she will be purchasing property of equal value (100 thousand dollars).

Finding a replacement property seller who is willing to increase the sales price, and make improvements before closing, may be difficult.  One other approach to this is to have the QI (or qualified intermediary) purchase the replacement property for ,000 – then take the title into an LLC that is owned exclusively for the purpose of a 1031 exchange, and use the remaining money from the exchange to make improvements to the replacement property.

So likewise, your QI can fund the improvements during their construction, holding the property for you and paying for everything with the proceeds from the exchange. When the improvements to the replacement property are finished, the investor can complete the exchange by receiving the property from the QI.

Consider the following things when you attempt to use a build to suite exchange. First, the 180-day requirement in order to complete a 1031 exchange does not allow sufficient time for an elaborate Build to Suit.  But, this should be enough time to rehab and update an already standing building.

Secondarily, to be considered an actual "like kind" exchange, any of the improvements to the replacement property must constitute "real-estate", i.e., real estate for real estate. Just dumping the building supplies on the location of your property won’t be enough, to constitute "real estate" those materials must be made a permanent part of the structure or affixed into the land.

Keep the foregoing in mind and you can avoid any pitfalls and get all of the tremendous tax benefits of a 1031 exchange that is build to suit.