Many clients desire to complete a 1031 exchange by not only applying a portion of the proceeds from the sale of relinquished property towards the subsequent purchase of a replacement property, but also using the proceeds for construction of certain improvements to that property.
The IRS has strict regulations on a taxpayer’s ability to use exchange proceeds towards construction costs on replacement property. Exchange proceeds may only be used to purchase real estate, not labor and materials. To resolve this dilemma, title to the property must be temporarily vested in the name of an Exchange Accommodation Titleholder (EAT) until construction is complete.
To facilitate construction exchanges in which Rattikin Exchange is involved, we have formed a separate holding entity, Texas Reverse Exchange Holding Company, L.L.C., to act as EAT and hold title pending the completion of construction on the replacement property.
In order to initiate a construction exchange, you must first appoint Texas Reverse as Exchange Accommodation Titleholder, and execute several instruments required to document the exchange, including the following:
At closing, Texas Reverse will purchase the property with exchange proceeds loaned to Texas Reverse by Rattikin Exchange. Texas Reverse will hold the balance of the exchange proceeds in Texas Reverse’s escrow account pending completion of improvements to the property, making periodic draws as appropriate for payments to the contractor. Upon the completion of the construction, Texas Reverse will deed the improved property to the client by Special Warranty Deed, completing the exchange.
In the event the property purchase and the construction cost will exceed the balance of the exchange proceeds, the client will need to arrange for financing through a third party lender.