Improvement and Build-to-Suit Exchanges Explained

An improvement exchange, sometimes called a construction exchange or build-to-suit exchange, allows exchange proceeds to fund new construction or renovation on replacement property before the investor takes title. The structure uses the same exchange accommodation titleholder mechanism found in a reverse exchange, adapted to fund construction rather than simply parking title.

How the Structure Works

The exchange accommodation titleholder takes and holds title to the replacement property and contracts for improvements using exchange funds. The investor then receives title to the property, including the completed improvements, before the one hundred eighty day deadline expires.

What Counts Toward Exchange Value

Only improvements that are substantially completed and in place by the time the investor takes title count toward the exchange value. Work completed after title transfers to the investor does not add exchange value, even if it is paid for with remaining exchange funds.

Common Uses in the Washington DC Metro Area

Build-to-suit exchanges suit investors constructing a single tenant retail building for a corporate tenant, renovating an aging multifamily property in a neighborhood such as Anacostia or Deanwood, or completing tenant improvements on medical office space before a healthcare tenant occupies the building.

Timeline Risk

• Permitting delays, which are common in historic districts
• Material and labor availability
• Weather related construction delays
• Inspection and occupancy certificate timing at the local jurisdiction

Basis and Depreciation on Improvement Value

Improvements completed during the exchange accommodation period generally carry over into the depreciable basis of the replacement property once title transfers to the investor. This differs from a renovation completed after the investor already owns the property, which is simply a capital improvement added to an existing basis. Coordinating the construction schedule with the exchange timeline can therefore affect both how much exchange value is preserved and how the improvement value is depreciated going forward, which is a detail worth confirming with a tax advisor before construction begins.

Insurance and Liability During Construction

Because the exchange accommodation titleholder holds legal title during construction, insurance coverage, contractor liability, and permit responsibility typically run through that entity rather than directly through the investor. Investors should confirm that builders risk insurance, general liability coverage, and any required District of Columbia or local jurisdiction permits are properly issued in the name of the titleholder, and that the investor is named as an additional insured where appropriate, before construction begins on the parked property.

Financing an Improvement Exchange

Improvement exchanges frequently require construction financing in addition to the exchange funds already on deposit with the qualified intermediary, since the value of raw land or an unimproved building plus the cost of construction can exceed the proceeds available from the relinquished property. Lenders willing to finance a loan to an exchange accommodation titleholder, rather than directly to the investor, are less common than standard commercial lenders, so identifying a lender comfortable with this structure early in the planning process helps avoid delay once the exchange begins.

Coordinating Contractors and the Exchange Accommodation Titleholder

Construction contracts should run through, or be approved by, the exchange accommodation titleholder, since that entity holds title during the improvement period. Draw schedules should align with the exchange timeline, and investors should maintain a contingency plan in case improvements are not complete by day one hundred eighty.

Selecting Properties Suited to an Improvement Exchange

Improvement exchanges work best when the scope of construction is well defined before the exchange begins, such as a build-to-suit lease already signed with a tenant, or a renovation scope already priced with a general contractor. Open ended construction scopes, or projects still working through the entitlement process with the District of Columbia or a local jurisdiction, introduce timeline risk that is difficult to manage inside the fixed one hundred eighty day deadline.

Frequently Asked Questions

What happens if construction is not finished within one hundred eighty days?

Only the value of improvements actually completed and in place by the deadline counts toward the exchange. Unfinished work at the deadline does not add exchange value, which can create boot if the completed value is less than the relinquished property value.

Can an investor act as the general contractor on an improvement exchange?

An investor can manage construction, but title to the property under construction is held by the exchange accommodation titleholder, not the investor, until the exchange concludes. Contracts and draws typically run through that entity.

Does an improvement exchange require a larger qualified intermediary fee?

Generally yes, because the structure involves an exchange accommodation titleholder, construction draw administration, and additional legal documentation beyond a standard exchange.

This article provides educational content only. It does not constitute tax, legal, or investment advice. Section 1031 defers federal income tax on qualifying real property and does not remove Washington DC transfer or recordation tax obligations. Consult a qualified tax advisor or attorney before acting on any exchange timeline.