1031 to build on land I already own

[Michelle Manning]

I am looking to sell 2 duplexes that are not cash flowing well. I own some land and already have plans to put a quad plex on it. Can I use my 1031 exchange to build the quad? Or split it and use some to build on another parcel of land that has room to add a SFM for rental? 
Non-real estate Accountant mentioned that I would need to go through an EAT, which sounds fairly complicated. Any advice or experience?

TIA

[Bill Exeter]

Hi @Michelle Manning, 

Yes, it can be done but not without risk or complexity. 

You would sell one or more properties (“relinquished property”) and subsequently build or make improvements on land that you already own (“replacement property”). The general idea is that you must acquire an interest in real estate that you do not already own, and since you already own the land you have to structure an Advanced Improvement 1031 Exchange so that you can acquire an interest in real estate that you do not already own (in fact, it does not exist yet).

Essentially, your new replacement property will consist of (1) a thirty plus year ground lease on your land, and (2) the new improvements made on the land that you already own. The ground lease and improvements represent the interest in real estate that you do not already own (and that is being created through this structure).

This is an Advanced Improvement 1031 Exchange, and as such, there are inherent risks involved in the transaction, some of which will be discussed below. You and your accountant and/or attorney should review in greater detail to ensure that you understand the risks involved.

The transaction involves the sale of your relinquished property through a Qualified Intermediary.  You would also need an Exchange Accommodation Titleholder or EAT. The EAT would sign the 30 plus year ground lease for your land. This 30 plus year ground lease begins to create an interest in real estate that did not exist before. The EAT would then begin to complete the improvements on the land that you already own in the name of and on behalf of the EAT. The 30 plus year ground lease plus the improvements made to/on the land creates/represents the new real estate interest that you will be identifying and acquiring as your replacement property in your 1031 Exchange.

RISKS

Private Letter Rulings

There are three (3) Private Letter Rulings (“PLRs”) that address this Advanced Improvement 1031 Exchange structure/strategy, which are as follows:

Private Letter Ruling Number 2014-08019
Private Letter Ruling Number 2003-29021
Private Letter Ruling Number 2002-51008

The PLRs can only be relied upon by the individual taxpayers that requested the PLRs. This means that should you be audited the PLRs can NOT be used or cited as precedent and it is always possible that the IRS could disqualify this 1031 Exchange. However, the fact that we have three (3) PLRs is a good indication that the IRS will permit this strategy. The PLRs will rarely match your proposed transaction either, which would increase the risk to you since your transaction will likely not be able to follow the PLRs exactly. 

The more you deviate from these Private Letter Rulings the more risk you will have.