Build-to-suit exchanges.

AuthorHamill, James R.
PositionLike-kind exchanges; taxation

Sec. 1031 allows for non-recognition of gain when property held for investment or trade or business use is exchanged for like-kind property. A common problem is how to handle an exchange in which all or a portion of the replacement property is to be constructed. This "build-to-suit" exchange is permitted by the deferred exchange regulations, but must be carefully structured to ensure that a taxpayer is treated as receiving the replacement property from a party to the exchange, not building the improvements as a principal.

Sec. 1031(a)(3) allows an exchange to qualify for non-recognition treatment if replacement property is both identified within 45 days of transfer of the relinquished property and received within 180 days of such transfer. (The latter may need to be assured by extending the due date of the taxpayer's return.) Regs. Sec. 1.1031(k)-1(e) describes how to identify property to be produced and, in the case of a real property exchange, allows construction-in-progress to qualify as replacement property if it constitutes real property under local law. However, Regs. Sec. 1.1031(k)-1(e)(4) does not permit an exchange of real property for construction services, including any services to be performed following the expiration of the statutory replacement period. Thus, a practical problem with many build-to-suit exchanges is the inability to complete the improvements within the allowed replacement period.

A tax adviser may be asked whether improvements may be constructed on land the taxpayer already owns. Because the taxpayer must exchange property with another party, such a plan is very difficult to fit under Sec. 1031. Simply contracting for improvements on land already owned would involve an exchange for construction services that would be taxable; see Bloomington Coca-Cola Bottling Co., 189 F2d 14 (7th Cir. 1951). The taxpayer would need to first transfer ownership of the land to another party, who would then build the improvements and transfer the land and improvements back to the taxpayer. Structuring such an arrangement without creating an agency relationship between the taxpayer and the other party (which would defeat nonrecognition treatment) may not be possible.

The IRS has approved certain build-to-suit structures. For example, in Rev. Rul. 75-291, a corporation (X) agreed to exchange its land and factory for land to be purchased by another corporation (Y) and improvements to be constructed thereon. The ruling stated that Y...

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