Improvement Exchange: Expanding Opportunities and Solutions for 1031 Exchanges

by Maura Snabes, Esq., CES, NTP

February 2025

One of the most challenging aspects of a 1031 exchange for taxpayers is identifying and acquiring a Replacement Property that aligns with their specific needs and preferences. Often, taxpayers feel pressured to "settle" for a property just to meet the strict timelines for identification and acquisition set forth in the 1031 exchange rules.

However, an increasing number of taxpayers are embracing the Improvement Exchange, or "build-to-suit" exchange, which allows them to build or enhance a Replacement Property to better fit their requirements.

What is an Improvement Exchange?

The IRS introduced reverse and improvement exchanges for 1031 transactions on September 15, 2000, with the issuance of Revenue Procedure 2000-37. An Improvement Exchange enables a taxpayer to work with an Exchange Accommodation Titleholder (EAT) to acquire vacant land or an existing property, then build improvements or make substantial renovations that align with their needs.

When Should It Be Used?

An Improvement Exchange is typically employed when the property a taxpayer intends to acquire in the exchange is not of equal value to or greater value than the Relinquished property or when significant capital improvements are necessary to the Replacement Property. For example:

In this scenario, the taxpayer achieves full deferral of gain, as the value of the Replacement Property after improvements matches the Relinquished property’s value.

Construction and Improvements:

Improvements don't need to be fully completed by the end of the exchange period, but the goal is to use as much of the exchange funds as possible during the exchange period. The taxpayer cannot prepay these improvements—what qualifies are only those improvements that are actually completed and on the property during the exchange period. In addition, any improvements that are done after the exchange period and after the taxpayer has taken title to the Replacement property will not be treated as the receipt of property of like-kind.

Key Challenge: Identification Process

A major challenge with the Improvement Exchange is the identification of the Replacement property, which must be done within the 45-day period after the closing of the Relinquished property. The identification must include a legal description of the land and as much detail as possible regarding the planned improvements. It’s crucial for taxpayers to work closely with their CPA or tax advisor to ensure proper and timely submission of the identification.

Bottom Line:

While an Improvement Exchange is more complex than a traditional forward exchange, it offers a valuable opportunity for taxpayers who want to build or significantly remodel a property to meet their exact needs—especially when the seller is unwilling or unable to make such changes before acquisition. There’s also the option for a reverse improvement exchange, where the taxpayer, through the EAT, acquires a Replacement property and makes improvements while the Relinquished property is still in process of being sold.

CXS has successfully managed hundreds of improvement exchanges. Trust Corporate Exchange Services to expertly handle your next Improvement or Reverse Improvement Exchange.