1031 construction exchange

[Mathew Burnett]

Once I build myself my first house, I want to sell it and put the profits towards building a fourplex. But I can't find a definitive answer on whether I can use a 1031 exchange to build a building or not or how easy would be to do. Does anyone know anything about this?

[Dave Foster]

@Mathew Burnett, Think of the construction part as a second and separate process that is in addition to the regular 1031 exchange.  You are completing an investment property right now that you'll be using for investment for a while and then you'll want to sell it and 1031 into a newly built 4 plex (that you build).  That's the regular 1031 exchange part.  The other part is the "reverse construction part where your QI takes title to the lot you want to build on and holds it until the value is high enough to absorb your 1031 amount.

In order to defer all tax you must purchase at least as much as you sell and use all of the proceeds in the 1031.  So as long as the construction and land acquisition value (not appraisal - actual hard costs) are equal to or greater than the net sales price of your current house you'll defer all tax.  You can add funds to that from any source.  Say your current home sells for $200K and the completed cost of the 4 plex is $400K.  You can bring that other $200K from any source - cash or leverage.  That parts no problem.

What is the most difficult issue is getting your construction done within the time limits.  A construction exchange is really just a form of a reverse exchange.  You'll find the lot you want to purchase and the QI will take title to it.  You will then start construction and from the day that the QI takes title to the lot you have 180 days to complete construction (or at least enough construction to absorb your 1031) and close the sale of your old property.

180 days sometimes cuts it thin since things like permitting and architecture take a lot of time but don't involve a lot of cost.  So you may want to explore with the seller of the lot some ways to let you get further down the road on the permitting process before having the QI take title.