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Since the Tax Reform Act of 1984 codified the 180-day exchange period under IRC Section 1031, real estate investors have wrestled with the provision that requires that any replacement property acquired in a like-kind exchange be received by the Taxpayer within 180 days from the date the old property is transferred.

This deadline is even more vexing to the Taxpayer who is trying to complete construction during the exchange period. Any number of factors can contribute to construction delays. Zoning variances, delayed building permits, financing, and inclement weather can create calendar chaos. And because the rules regarding construction are fairly stringent - any improvements made to the property after it is received by the Taxpayer are not considered "like-kind" to real estate - Taxpayers often find they are racing against the clock to complete a project.

There are several techniques a Taxpayer can consider using that maximize the value of the replacement property while minimizing the tax and business risk.

1. Third party seller constructs improvements and transfers improved property to Taxpayer.

The seller agrees to undertake construction of improvements and then transfers the improved property to the Taxpayer within the exchange period. The upside: Taxpayer can use sale proceeds to make progress payments as the property is improved. The downside: It is unlikely you'll find a seller who is willing to undertake construction on property it's trying to sell. If you are lucky enough to find an accommodating seller, you still may not be able to secure your interest in the property during the exchange period.

2. Professional developer/builder acquires property from third party seller and constructs improvements.

In this structure, legal title to the property is transferred to a professional developer who manages the construction within the exchange period. The upside: Taxpayer can use exchange proceeds to pay for the land to be transferred from the seller to the developer, as well as to fund the cost of the improvements. The construction process is managed by a professional, which should result in greater efficiency. Taxpayer may be able to secure its interest in the property by recording a mortgage against the property for the value of the land. The downside: Double transaction costs, fees to developer, and the Taxpayer may not have a security interest in the value of the improvements during the exchange period.

3. Qualified Intermediary acquires property from third party seller.

Taxpayer manages construction process. Seller transfers the replacement property to a special purpose entity ("SPE") owned by the Qualified Intermediary.

The SPE acquires the property with exchange proceeds and enters into a construction management agreement with Taxpayer. Taxpayer then oversees the construction process either directly, or through a separate entity. The upside: Taxpayer has direct control over the project and may have a security interest in the property by appointment to the board of directors of the SPE that owns the property. The position allows the Taxpayer to block any voluntary bankruptcy proceedings brought by the SPE. Taxpayer has ready cash to fund the acquisition of the land and, often, some percentage of the improvements. The downside: Double transaction costs, additional fees to the Qualified Intermediary, and fees to the developer.

4. Taxpayer structures a reverse exchange "parking arrangement" under Revenue Procedure 2000-37.

Exchange Accommodation Titleholder ("EAT") holds property while improvements are constructed. Similar to the scenario described in number three on the previous page, seller transfers the replacement property to an SPE that is owned by EAT, who leases it back to the Taxpayer. The EAT retains ownership of the property, but in all other respects, the Taxpayer has complete control over the property and the project. The upside: Taxpayer can make improvements to replacement property prior to selling its old property - a desirable result when Taxpayer needs to construct and move into a new operating facility prior to moving out of an existing facility. Additionally, in these transactions, the Taxpayer can be named as a second non-economic member of the SPE that is owned by the EAT as additional protection against bankruptcy filing. The downside: Since the Taxpayer has not yet sold its old property, it may have difficulty arranging financing for the purchase of the new property without available cash. Also, if the Taxpayer cannot sell its old property within 180 days from the date the EAT acquires the new property, the EAT puts the property back to the Taxpayer, resulting in no exchange and no tax benefit.

Additionally, two private rulings [PLR 200251008 (September 2002) and PLR 200329021 (April 2003)] deal with situations where an EAT acquires a long-term leasehold interest from a party related to Taxpayer, constructs improvements, and transfers the leasehold and improvements to Taxpayer as replacement property.

The IRS, while acknowledging that the transactions involved exchanges between related parties, concluded that the transactions qualified for non-recognition of gain treatment under Section 1031 since "both the Taxpayer and the related parties continue to be invested in the exchange properties."

This conclusion is questionable, particularly in the second ruling where the related party assigned its leasehold interest to the EAT and, thus, was no longer invested in the property.

Subsequent guidance from the IRS on related party exchanges (Revenue Ruling 2002-83) casts doubt on the validity of any exchange where a Taxpayer acquires replacement property from a related party.

Build-to-suit exchanges can be fraught with challenges and obstacles that try the most determined real estate investor. The structuring opportunities are many, as are the risks. However, with careful planning and some creative thought, these transactions can be structured in a manner that should qualify under Section 1031.