IMPROVEMENT BUILD-TO-SUIT EXCHANGE

An improvement exchange, sometimes called a build-to-suit exchange or construction exchange, allows an investor to use exchange funds to construct or improve a replacement property rather than simply purchasing it as is, which is useful when the best available replacement property is priced below the relinquished property's value or needs substantial work to match the investor's investment goals. Because an investor cannot take title to the replacement property and then use exchange funds to improve property they already own, improvement exchanges rely on the same exchange accommodation titleholder safe harbor under Revenue Procedure 2000-37 used in reverse exchanges. The exchange accommodation titleholder holds title while construction proceeds, using exchange funds directed by the qualified intermediary to pay contractors and suppliers, and title transfers to the investor once the exchange is complete. This guide explains how construction is structured within the exchange timeline and what the identification notice must include for property that is not yet finished.

Structuring Construction Within the One Hundred Eighty Day Window

The full construction budget must be spent, and the improvements substantially completed, within the same one hundred eighty day window that governs every 1031 exchange, which makes an improvement exchange considerably more time sensitive than a standard purchase of a finished property. Investors and their contractors in Philadelphia, PA need a realistic construction schedule before committing to this structure, since permitting delays, material lead times, and inspection scheduling with the Department of Licenses and Inspections can all consume weeks of the available window. Because the exchange accommodation titleholder holds legal title during construction, draw requests and contractor payments flow through the qualified intermediary rather than directly from the investor, which adds a coordination step to a process that would otherwise be a normal construction draw schedule. Any construction budget that is not actually spent by the time the exchange must close is treated as cash boot returned to the investor, so accurate budgeting before the exchange begins matters as much as the construction schedule itself.

Improvement exchanges are most often used when the replacement property is raw land that will be built out, an existing building that needs substantial renovation to reach the value of the relinquished property, or a build-to-suit arrangement for a single tenant that requires site work before the tenant can take occupancy. The structure lets an investor apply exchange funds toward that construction rather than paying for it separately with after-tax dollars, but the funds must be spent on the specific parked property held by the exchange accommodation titleholder, not on other property the investor already owns. Because draw requests must pass through the qualified intermediary rather than being paid directly by the investor to the contractor, we recommend Philadelphia, PA investors negotiate a construction contract with a draw schedule tied to verifiable milestones, such as foundation completion, framing, and rough inspections, so the qualified intermediary can release funds against documented progress rather than a fixed calendar schedule that may not match actual construction pace. Weather delays, material lead times for structural steel or mechanical equipment, and inspection scheduling with the Department of Licenses and Inspections are the most common reasons a Philadelphia, PA improvement exchange runs behind its original schedule, so we build contingency time into the construction plan from the outset rather than assuming every milestone will be met on the first attempt.

Identification Requirements for Property Under Construction

When the replacement property will not be finished within forty five days, the identification notice must describe the property as specifically as possible given the stage of construction, including the legal description of the land and a description of the improvements that are planned or underway. The Internal Revenue Service has indicated that identification of property under construction should describe the improvements as of the expected completion date to the extent practical, which means Philadelphia, PA investors using this structure typically work with the qualified intermediary and exchange accommodation titleholder to draft an identification notice that reflects the construction plans, not just the current condition of the land.

We help Philadelphia, PA investors evaluate whether an improvement exchange fits the construction timeline realistically available, coordinate with an exchange accommodation titleholder experienced in build-to-suit structures, and confirm the identification notice adequately describes property that will still be under construction on day forty five. In some transactions, an improvement exchange is paired with a reverse exchange because the replacement property is both being built out and needs to be parked before the relinquished property has sold, which layers the construction timeline on top of the parking arrangement and typically requires the exchange accommodation titleholder, the qualified intermediary, the lender, and the general contractor to coordinate on a single shared schedule rather than managing the financing and construction timelines separately, and we recommend that combined structure only when the underlying replacement property is clearly worth the added coordination cost. We also confirm insurance coverage for the property under construction, since a builder's risk policy generally needs to be held in the exchange accommodation titleholder's name during the parking period and then transitioned to a standard property policy once title passes to the investor.