A 1031 Improvement Exchange might be perfect for the Lake of the Ozarks

Lake of the Ozarks buyers and sellers can save a bundle of money if the situation is right to use a 1031 exchange. It’s not for every purchaser, and not something you want to do all by yourself, but it can be a powerful to leverage your purchase and build tax free wealth!

Internal Revenue Code section 1031 allows for an improvement exchange on like-kind property. Great - so what does that mean? Say you own raw land, a rental duplex, a house your kid is living in for college on the 6 year plan, or even a building that houses your current business. You can sell that property and buy a Lake of the Ozarks vacation home or condominium. Given our latest appreciation rates, this would make sense to do, and you’d owe no capital gains on the money you made on this transaction. This is a great thing on the surface, and would be worth doing if it meets your investment requirements. What if I told you this situation could be made even better using a reverse exchange and /or an improvement exchange? Let me illustrate with an example.

Joe Investor owns a business that includes the real estate where his business is housed. Joe has been approached by buyers that would like to buy his building, and would give him a long term triple net lease as a sale leaseback so Joe could continue to operate his business from that location. Joe has always loved to boat and wanted to retire to the Lake of the Ozarks in a few years anyway, so why not buy now before prices go even higher? Joe accepts the offer of the sale/leaseback of his building for $595,000, and shelters $350,000 from capital gains. In a traditional exchange, Joe would need to buy a Lake home or condo with a price greater than $595,000.

Joe is a smart guy, and has found a townhome listed By The Lake Select Group at RE/MAX Lake of the Ozarks. It needs a little work, but it has a cruiser slip and is for sale for $520,000. Joe makes an offer and puts the property under contract for $505,000. But wait, won’t the IRS nail Joe for "boot", on the balance of the $595,000 - $515,000 = $90,000. No, because Joe is doing a 1031 Improvement exchange and plans on spending that $90,000 on all new flooring, adding an outdoor kitchen, and a kitchen and bathroom remodel project. Joe will not owe capital gains on his building, and will have a property that is remodeled exactly the way he wants it. That is slicker than grease!

The potential problem here is that just like a traditional 1031 exchange, you have 45 days to identify and 180 days to complete the purchase. Not only must the property close, but the repairs and remodel must be done within 180 days, or at least to the dollar amount that is above your relinquished property price ($595,000 in this example). You can prove this by having an appraisal done and in hand for the closing.

If Joe was adding on structurally, or say was building a new house altogether, the Lake Select Group would recommend he use a 1031 reverse improvement/construction exchange. This cost a bit more money, but buys you valuable time for the construction and other work. A special entity called Exchange Accommodation Titleholder (EAT) will purchase and hold the property until the exchange is completed. This way Joe can start getting permits prior to close and construction could begin on day one, giving the full 180 days to build or remodel. The EAT owns the property, and will pay all the bills, then the property is transferred from the EAT to Joe.

You need to work with an agent like the Lake Select Group that is used to explaining these transactions because your local banker will not like the fact another entity will be owning this property for a short period of time. This is easy enough to remedy, if you have the experience to properly explain it, and a reputable and knowledgeable qualified intermediary is a must in this case. The $3000 or $4000 you’ll pay the QI to act as the EAT is money well spent, for the time it buys you as well as the fact when you find the right replacement property, you can go ahead and pull the trigger on the sale of the replacement property before you have even put your relinquished up for sale.

If you have any questions about 1031 exchanges or buying or selling Lake of the Ozarks real estate, you can always contact John Garrett at 573-302-2320 or e-mail us for a fast response.

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