An improvement property or “build-to-suit” property typically refers to a replacement property that is acquired and improved using the proceeds from the sale of a relinquished property.
In a traditional 1031 exchange, the seller or “exchanger” sells a property and then buys another “like-kind” property to defer paying capital gains taxes. However, sometimes the exchanger wants to use the proceeds to not only purchase a new property but also to make improvements to that property.
In this case, they can engage in an “improvement” or “build-to-suit” 1031 exchange. The exchanger sells their property, and the proceeds go to a qualified intermediary. The exchanger then identifies a replacement property, and the qualified intermediary acquires this property. Instead of immediately transferring the property to the exchanger, however, the intermediary holds the property and uses the exchange funds to make agreed-upon improvements to the property.
Once the improvements are complete or the 180-day exchange period is over (whichever comes first), the intermediary transfers the improved property to the exchanger. This allows the exchanger to defer capital gains taxes not only on the sale of their property but also on the improvements to their new property.
It is essential to consult with a tax advisor or 1031 exchange expert to ensure the process is carried out correctly as the IRS has strict rules about how these exchanges must be conducted.