Construct Improvements to Replacement Property
Occasionally the taxpayer
disposes of a property in an exchange and desires to construct improvements or make
repairs on the replacement property. If the taxpayer receives cash from the exchange and
then makes the improvements, the cash is considered taxable boot.
In order to count the improvements as
part of the cost of the replacement property in the exchange, consider the following
alternatives:
- As part of the negotiations on the replacement property, request the seller to make the
repairs and improvements. If the seller is not in a position to pay for the improvements
prior to closing, consider increasing the earnest money and releasing it to the seller. As
an alternative, the intermediary could loan the money to the seller secured by a deed of
trust on the replacement property.
- The intermediary could take title to the replacement property, complete the improvements
and then transfer title to the taxpayer. The title to the replacement property would have
to be transferred to the taxpayer within 180 days of closing on the relinquished property.
- An unrelated construction contractor could acquire the land and construct the
improvements under contract with the intermediary. The builder should not be the agent of
the exchangor. When the construction costs for the improvements exceed the selling price
for the relinquished property, the replacement property can be transferred to the
exchangor but in any event not more than 180 days.
The
property could be transferred to the taxpayer sooner than 180 days after closing on the
relinquished property if construction is completed or when the cost of the improvements
plus the land have exceeded the sales proceeds of the relinquished property. 