The improvement exchange allows a taxpayer, through the use of an Exchange Accommodation Titleholder (EAT) owned by a qualified intermediary, to make improvements on a replacement property using exchange equity. In other words, a taxpayer can maximize investment opportunities using tax-deferred dollars by building or improving a replacement property in a 1031 exchange. This type of exchange is also referred to as a construction or build-to-suit exchange.

Improvement exchanges offer taxpayers a wide array of benefits which often result in a better investment than properties readily available on the open market. The ability to refurbish, add capital improvements, or build from the ground up, while using tax-deferred dollars allows a taxpayer to reinvest in a replacement property that meets their precise business needs or investment criteria. Due to the additional options provided by this variation and because Revenue Procedure 2000-37 created a “safe harbor” and established parameters for improvements to be produced, improvement exchanges continue to increase in popularity.

Another benefit of the improvement exchange format is that the replacement property does not necessarily have to be fully completed within the 180-day exchange period. A certificate of occupancy is not required.

A taxpayer must meet three basic requirements in order to defer all of their gain in the improvement exchange format. The taxpayer must: 1) spend the entire exchange equity on completed improvements or down payment by the 180th day; 2) receive substantially the same property they identified by the 45th day; and 3) the replacement property must be of equal or greater value when deeded back to the taxpayer. The final value of the replacement property is the combination of the original purchase price plus the capital improvements made to the property. [Note: The improvements need to be in place prior to the taxpayer taking title to the replacement property if the taxpayer is seeking full tax deferral.]

The improvement exchange is commonly utilized to the benefit of taxpayers in the following situations:

  • The property to be acquired in the exchange is not of equal or greater value to property being sold. In this case, the improvement exchange can eliminate a taxable situation by adding capital improvements to an existing property.
  • To build a new investment from ground-up. This example maximizes the investment opportunity in a given area by enabling a taxpayer to build a replacement property that meets their exact requirements.

The main obstacle in this type of 1031 exchange occurs when there is a lender involved. This is true because, throughout the improvement process, the EAT is on title to the replacement property.


The improvement exchange (sometimes referred to as a construction or build-to-suit exchange) is a parking arrangement strategy that enables a taxpayer to improve a replacement property. Although this parking arrangement structure provides tremendous flexibility and opens up a vast array of potential replacement property options, a couple of additional requirements must be followed to obtain full tax deferral.

Identification of Property to be Produced

The Treasury Regulations states the following regarding identifying a replacement property: “…a legal description is provided for the underlying land and as much detail is provided regarding construction of the improvements as is practicable at the time identification is made.” This means the taxpayer should identify not only the property being improved, but also specify the exact improvements to be made to the replacement property. Often this is accomplished by identifying the parcel of land and providing a copy of the blueprints or construction drawings. The IRS does allow for running construction changes, such as relocating an interior wall by a couple of feet, changing the pitch of the roof, etc. Nevertheless, it is critical the property received by the taxpayer is substantially the same as the property identified.

Receipt of Property to be Produced

To qualify for a “safe harbor” improvement exchange (within the 180-day maximum exchange period) a taxpayer must actually receive like-kind real property, not services to be produced any time after the expiration of the exchange period. Any exchange proceeds that are not reflected in actual improvements to real property within the 180-day exchange period are considered boot since production services to be built in the future are not like-kind real property. The Treasury Regulations specifically states the following: “…is not within the provisions of Section 1031(a) if the relinquished property is transferred in exchange for services (including production services). Thus, any additional production occurring with respect to the replacement property after the property is received by the taxpayer will not be treated as the receipt of property of like-kind.”