Can 1031 into a lot?

[Dave Carter]

Is it possible to sell a rental and 1031 into a lot that you intend to build a duplex or four plex on? The new property has to cost more than the sale, and it will would when built, but it won’t as an unimproved lot. Can the cost of the lot and an appraisal-based construction loan qualify as the subject property?

[Dave Foster]

@Dave Carter, There's a way to do this.  But it's not as straight forward you'd hope.  The 1031 exchange has to be a sale of real estate and a purchase of real estate - actual purchase price.  You cannot use a future appraised value.  

You also cannot exchange into improvements on property you already own.  This is because improvements (construction) you put on land you already own are not considered real estate.  So you're left with the options of using your 1031 to purchase the land only.  Or to find completed construction to purchase to complete your 1031.

Or you could do what is called a "reverse construction exchange".  In a reverse exchange the intermediary for the 1031 actually holds title to the lot until construction is done.  At that point you can finish your 1031 exchange by "purchasing" the new property from the QI.  And because the improvements are attached to the land they would now be considered to be real estate and count towards your reinvestment requirements.

There are some complications with reverse exchanges

1. They're complex and expensive

2. Financing can be an issue as you have to provide the financing but you will not own the lot or construction being placed on it.

3. You only have 180 days to complete the construction (or take title to whatever is completed) unless you do a form of reverse exchange that does not fall under the safe harbor of rev proc 2000-37.  As expensive as a regular reverse exchange is, a non-safe harbor reverse going past 180 days will cost you many multiples of that.