Built-to-Suit 1031 Exchange

Requirements and Procedures

A built-to-suit exchange is when Downstream Exchange Company acquires the Replacement Property. Downstream improves the Replacement Property during the 180-calendar day exchange period. The Internal Revenue Service regulations require that improvements be made to the Replacement Property before the Exchangor receives the Replacement Property.

Requirements

For your property to qualify for a 1031 exchange, the following must be true:

Both the Relinquished Property and the Replacement Property must be held for either investment or productive use in a trade or business.

The property must be Like-Kind Property. Real property must be 1031 exchanged for real property.

There must be a reciprocal transfer of properties—a deed for a deed.

Procedures

Conveyance of Relinquished Property From Exchangor to Buyer

Timing and Identification Requirements

Conveyance of Replacement Property From Seller to Special Purpose Entity

Conveyance of Replacement Property From Special Purpose Entity to Exchangor

Practical Considerations

Important Issues to Take Into Consideration

Conveyance of Relinquished Property From Exchangor to Buyer

The escrow company handling the escrow for the Relinquished Property sends Downstream Exchange Company Escrow Instructions, and the Preliminary Title Report.
Downstream prepares Closing Instructions, an Exchange Agreement, an Assignment Agreement, and a Buyer’s Acknowledgment based on that information. Downstream then sends these documents to you for your signature as the Exchangor and to Escrow to obtain the Buyer’s signature

Timing and Identification Requirements

When the Relinquished Property escrow closes, you will receive:
- A letter from Downstream advising you of the date your escrow closed and the amount of funds Downstream received from escrow.
- A calculation of the actual calendar date of the 45th and 180th calendar day from the close of your escrow. You must identify the property you wish to acquire by the 45th calendar day from the close of your escrow and you must acquire the property you have identified by 180 calendar days of the close of your escrow.
- A property identification form included with the letter that you must return to Downstream by the 45th calendar day from the close of escrow of your Relinquished Property.
You may identify up to three Replacement Properties. Alternatively, you may identify any number of properties as long as their aggregate fair market value does not exceed 200 percent of the aggregate fair market value of the property you relinquished. As a final option, you may identify any number of properties as long as you acquire at least 95 percent of the aggregate fair market value of all the identified Replacement Properties before the 180 calendar day period ends.
The identification of a property may be revoked in writing at any time during the 45-day calendar period.
While Downstream is holding your funds, you will receive a monthly analysis advising you of the activity on your account. You will also receive an analysis of the activity in your account if we receive additional funds or make any payments authorized by you, the Exchangor.
We will send you a final analysis of the transactions after the close of escrow of your Replacement Property.

Conveyance of Replacement Property From Seller to Special Purpose Entity

The Replacement Property you acquire must be a property you intend to hold for investment for at least one year. Holding the property for investments means you cannot live in the Replacement Property.
At your request, we will send a deposit to the Replacement Property escrow when escrow opens.
The escrow company handling the escrow for the Replacement Property sends Downstream Exchange Company Escrow Instructions and the Preliminary Title Report.
Downstream prepares an Assignment Agreement, a Substitution Agreement, and an Amendment to Escrow Instructions from that information. Downstream will send you these documents for your signature as the Exchangor, the Special Purpose Entity, and the Seller.
Escrow deeds the Replacement Property to a Special Purpose Entity designated and affiliated with Downstream Exchange Company.
Downstream uses the proceeds from the exchange to improve the Replacement Property held by the Special Purpose Entity.
The Exchangor may use a construction lender to fund the improvements made to the Replacement Property.

Conveyance of Replacement Property from Special Purpose Entity to Exchangor

The Replacement Property you acquire must be a property you intend to hold for investment for at least one year. Holding the property for investments means you cannot live in the Replacement Property.
The Replacement Property owned by the Special Purpose Entity designated and affiliated with Downstream Exchange Company transfers 100 percent of the Special Purpose Entity to you, the Exchangor.

Practical Considerations

You have only 180 calendar days from the close of escrow for the Special Purpose Entity to acquire the Replacement Property, complete and pay for sufficient improvements to satisfy the investment requirement into the Replacement Property.
You may not include construction materials or services in the exchange value prepaid but not completed since they are not considered Like-Kind Property.
You do not have to fully complete the improvements on the Replacement Property to the point that the improvements are suitable for occupancy. You can value the Replacement Property as is conveyed to the Exchangor.
You may incur additional state, county, or local transfer taxes when you convey the Replacement Property from the Special Purpose Entity to the Exchangor.
The Exchangor should consult with the construction lender before entering the exchange to anticipate and resolve any problems the lender may anticipate when making the construction loan.
You may not improve a property that you already own.

Important Issues to Take Into Consideration

Generally speaking, to completely defer all capital gain taxes:
- You must use all of the net proceeds from your Relinquished Property to purchase your Replacement Property.
- You must also obtain a mortgage on your Replacement Property equal to, or greater than, the mortgage on your Relinquished Property.
- You can offset the mortgage obtained on the Replacement Property by putting the equivalent additional cash into the exchange.
Certain losses may affect the amount necessary to invest in the Replacement Property. You should consult with your tax preparer regarding your potential Recognized Gain.
In a 1031 Exchange, if the property exchanged is to or from a Related Party, it must be held for two years. Please email, call, or fax us for a further explanation if you feel this may apply to you.
It is also essential that you do not have actual or “Constructive Receipt” of the funds during the exchange process. No funds from the transaction should be received by the taxpayer until all Replacement Property has been acquired.
You cannot use a 1031 exchange for stock in trade, inventory, property held for sale, stocks, bonds, notes, securities, evidence of indebtedness, certificates of trust, or beneficial interest in trust or interest in a partnership.
If you use a 1031 exchange to exchange California real property for out-of-state real property, California tax law provides for the nonrecognition of gain on the 1031 exchange. A 1031 exchange allows you to defer the gain and reduce the purchase price of the real property received; however, if you move out of California and then sell the replacement real property outside of California, the portion of the gain attributable to the increase in value of the California real property during the period you held it will be income from California sources. You must report income from California on California Form 540 NR.
California has enacted a new statute effective for real estate exchanged in an Internal Revenue Code Section 1031 tax-deferred exchange in tax years beginning on or after January 1, 2014. This new California statute requires that California taxpayers who sell and exchange California property for out-of-state property must file an information return (FTB 3840) with the Franchise Tax Board for the year of the exchange and for every subsequent tax year. The purpose of this new statute is to allow the Franchise Tax Board to keep records of an exchange and then tax that taxpayer when they sell the out-of-state property.

The above information is provided for general information purposes only. You should discuss your actual individual property transaction with your current attorney, certified public accountant, or us.

We hope you find the above information helpful.

We know you will have questions about your transaction and encourage you to contact us. We will be pleased to assist you.

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