With a very limited inventory of available properties the
good ones are quickly snapped up. Properties that
languish on the market do so for a reason - many of them
have significant deferred maintenance. These properties
generate a lot of calls to our office. The primary question...
Can exchange funds be used to make the necessary
Yes,with the following requirements:
1. The improvements must be identified, and
2. The work must be performed before the Exchanger becomes the owner.
If the Exchanger can't be the owner, who will be?
There are several options:
Option 1 - Seller Owns and Improves
The Exchanger negotiates with the Seller to have the Seller make the
improvements and increase the sales price. (Sellers seldom agree to do this.)
Option 2 - Seller Owns and Exchanger Improves
The Exchanger negotiates with the Seller to allow Exchanger's contactor on
the property prior to closing to make the improvements. The closing occurs
after the work is completed. This is most often utilized when the project is of
short duration, for example, installation of a new furnace. (The risk to both
Seller and Buyer would cause most attorneys to blanch at the thought.)
Option 3 - EAT Owns and Improves
Utilizing Revenue Procedure 2000-37 the property can be "parked" with an
Exchange Accommodation Titleholder (EAT), a service provided by the
exchange company. The work takes place while the EAT owns the property.
This revenue procedure permits the Exchanger to fully manage and control
the property and project.
There will be additional expenses associated with the parking arrangement -
extra closing costs, tax advisor expense, lender fees, EAT fees, etc. When all
these expenses are tallied the cost can be $10k, or more. Utilizing the EAT
can make financial sense when the improvements are $100k, or more.
What does not work?
A holdback in escrow or prepayment of vendors and contractors does not
work. With either of these arrangements the work will be performed after the
Exchanger owns the property and is viewed by the IRS as the receipt of
"goods and services" not like kind real estate.
What if the improvements cannot be completed within the 180-day
As long as the improvements, when completed, are substantially similar to
what was identified, the Exchanger will get credit for the value in the ground at
the point the property is transferred to them.