How to do a Construction Exchange into Self Storage?

[Gary Lambert]

I am about to accept an offer on 2 large tracts of Timberland I own. I have found a tract of land that I would like to build Self Storage on. I do have to change the zoning on the property and feel fairly confident that I will be able to. There are several steps to that process but should be able to complete all of them by the end of July. I have done several basic 1031 exchanges but never a construction 1031. I have read up on them but no first hand experience. Any ideas or advice or companies to help me with this would be really appreciated. Thanks for the help

Gary Lambert

[Dave Foster]

@Gary Lambert,  The reverse exchange can be perfect when you find a property to purchase before you have closed your sale.  Or where the property you want use as your replacement is worth less than the property you're selling (or needs to be built as in your case).

Since you cannot take title to the new property before your old property sells.  And since you must exchange for actual real estate and cannot exchange into improvements on property you already own, the QI forms a holding entity called the Exchange Accommodating Title Holder (EAT) The EAT takes title to that land and then holds it while you control and use it.  So during the period of the reverse construction the EAT owns it but you control it, use it, and improve it.  So that at the end of the reverse exchange process it is now worth the value of the land plus the improvements on it.  

An example would be if you were selling your land for $600K were under contract to purchase the new land for $100K but it needed $500K of improvements to complete the self storage facility.  This would be a great candidate for a reverse construction exchange.  The EAT takes title to the land and then you build the facility on it.  At the end of the process the property is now worth $600K so it makes a perfect replacement property for your 1031 on the sale of your old property.

Think of the reverse construction exchange (purchase and improvement of the land) and the straight exchange (the sale of your old property and purchase of new property) as two different but complementary processes.

Biggest issues with a reverse

1. Timing - While the regular 1031 gives you 180 days from the date of your sale to take title to the new property.  The Reverse gives you 180 days from the day the EAT takes title to the new property to complete the sale of the old property.  So no matter how you slice it you only get 180 days for the entire process.  This isn't much time for construction - especially if you first have to go through a permitting and rezoning effort which are time consuming but add little value (from a dollar perspective)

2. Financing - You must provide the financing for the purchase of the new property and the construction of the facility.  This is usually a down payment from you and bank financing.  But it will have to be a portfolio or private lender.  Conventional lenders cant do them so think local bank or private lending source.  If there is an intermediate period of time when your old property has sold but you're not ready to complete that part of your 1031 it is fine to use your 1031 proceeds to provide the construction dollars.  The QI has to manage the disbursements in a special way.

3. Cost - While a regular 1031 might cost you 750 - 1000 a reverse exchange could add $4000 - $6000 more to the project.  Expensive but in the right scenario well worth it.