The Build-to-Suit Exchange, also referred to as the Construction or Improvement Exchange, gives the Exchanger the opportunity to use all or part of the exchange funds for modification or retrofit of the replacement property and accomplish a tax deferred exchange. This variation of the delayed exchange allows the Exchanger more flexibility, providing the opportunity to either retrofit, upgrade or refurbish an existing aircraft, vessel or business personal property. In the most common type of Build-to-Suit Exchange the Exchanger sells the relinquished property and then acquires the replacement property after it has been improved with the exchange funds. Any improvements made to the replacement property after the Exchanger takes title are considered to be "goods and services", and are considered not "like-kind" property and are taxable, including any remaining exchange funds, which will also be taxable as boot. Therefore, any improvements to the property must occur before the Exchang er takes title.

If the Exchanger wishes to include retrofit of the replacement property as part of the exchange, one option would be to contract with the seller to have the retrofit completed before the transaction closes and the Exchanger takes title to the property. (Holdback accounts do not work for exchanges.) Another option is to negotiate with a maintenance and refurbishment station to purchase the replacement property and complete the construction and then have the Exchanger buy the improved business personal property from the builder to complete the exchange. Where neither of these options will work, the Build-to-Suit Exchange is accomplished by using the Qualified Intermediary. In all cases it is important to remember that all applicable rules of IRC §1031 apply equally to Build-to-Suit exchanges. The Exchanger has 45 days to properly identify the replacement property, and no more than 180 days to acquire the identified property. Also, to be totally tax deferred, the Exchanger must ultimately acquire replacement property that is the same or greater value as the relinquished property, and all exchange equity must be used in the purchase of the replacement property and the addition of the improvements.

The Procedure

The Build-to-Suit exchange begins when the Exchanger sells the relinquished property. When the Exchanger enters into a contract to purchase the replacement property, the Exchanger assigns the rights in the contract to the Qualified Intermediary. The Intermediary uses a portion of the exchange funds to acquire their interest in the replacement property and holds title to the replacement property while it is being improved. On behalf of the Qualified Intermediary, the Exchanger or the Exchanger's contractor arranges for the retrofit to be completed on the replacement property. During the 180-day exchange period, the work-in-progress invoices are sent to the Qualified Intermediary for payment upon the Exchanger's approval. On the earlier of the end of the 180-day exchange period or the completion of the modifications the Qualified Intermediary transfers title to the replacement property to the Exchanger to complete the exchange. Any modifications to be included in the exchange must be built and paid for prior to the close of the exchange when the Exchanger takes title to the replacement property.

Important Issues

To have a valid exchange the Exchanger must properly identify the replacement property to be acquired within the 45-day identification period. In a Build-to-Suit exchange the replacement property does not exist in the form that it is to be later acquired and so the property identification rules for property to be modified are satisfied if a clear legal description is provided for the unimproved and as much detail is provided regarding the addition of the modifications as is practicable at the time identification is made.

• For new modifications the identification requires a specific description of the equipment (legal description or model/serial number) and a drawing or detailed summary of the new construction.
• Where the replacement property is an existing property in need of refurbishment or upgrade, the make and model of the equipment and a summary of the retrofit project will probably suffice.

For purposes of the 200% rule, the fair market value of the identified property is the estimated fair market value of the improved property at the time the Exchanger expects to receive it.