Sometimes the replacement property isn't worth enough as-is, or doesn't exist yet. An improvement (construction) exchange — also called a build-to-suit exchange — lets you use exchange funds to build or renovate the replacement property, completing enough work within 180 days to make the value and the deferral work. It's one of the more complex 1031 structures, with a genuinely tight timeline, but it solves a real problem: how to reach equal-or-greater value when the available replacement needs improvement. This guide explains the improvement exchange in full.
What Is an Improvement Exchange?
An improvement exchange lets you apply exchange proceeds toward improvements on the replacement property, so the value of those improvements counts toward your equal-or-greater-value requirement. An exchange accommodation titleholder (EAT) takes title to the replacement and makes the improvements while you complete the exchange.
This differs from a standard exchange, where you simply buy the replacement as-is. In an improvement exchange, you're effectively building value into the replacement using exchange funds, which lets you reach the value target you need or create a property to your specifications.
Like reverse exchanges, improvement exchanges use the parking structure under the IRS safe harbor (Rev. Proc. 2000-37), with the EAT holding title while the improvements are made within the 180-day window.
Why Use an Improvement Exchange
There are two main reasons to use an improvement exchange. The first is value: if the available replacement property is worth less than what you sold, building improvements with exchange funds lets you reach equal-or-greater value and avoid boot. The second is customization: a build-to-suit exchange lets you create a replacement property to your specifications.
For example, if you sold for $1,000,000 but the best available replacement is worth only $800,000 as-is, an improvement exchange lets you use $200,000 of exchange funds to improve it to $1,000,000 of value, achieving full deferral.
Without the improvement structure, that $200,000 gap would be cash boot (taxable) or would require finding a different, more expensive replacement. The improvement exchange bridges the gap by building value into the property you've chosen.
How Construction Funds Are Held
In an improvement exchange, the EAT takes title to the replacement property, and your qualified intermediary disburses exchange funds to pay for the construction or renovation as it's completed. You direct the improvements, but the EAT holds title and the QI controls the funds.
The funds are released against completed, paid-for work — you can't simply pre-fund the full improvement budget and count it. Only improvements actually finished and paid for during the exchange period count toward your replacement value.
This structure keeps the exchange funds within the like-kind exchange framework while they're used to build value, with the EAT and QI ensuring the parking and disbursement follow the safe harbor.
The 180-Day Constraint
The defining challenge of an improvement exchange is the 180-day window. Everything — the acquisition and all the value-adding improvements — must be completed within 180 days of the relinquished sale. The EAT can hold the parked property for no more than 180 days under the safe harbor.
This is a genuinely tight constraint, because construction rarely respects deadlines. Permitting, weather, contractor availability, and supply delays can all push work past day 180, and any improvements not finished and paid for by then don't count toward your replacement value.
The 180-day limit is why improvement exchanges require realistic, achievable construction scopes and reliable contractors. Ambitious builds that can't plausibly finish in 180 days are poor candidates for an improvement exchange.
What Counts Toward Value
Only improvements actually completed and paid for within the 180-day window count toward your replacement value for the equal-or-greater-value test. Work in progress, materials on site but not installed, or improvements completed after day 180 don't count.
This is the central planning point: you must be confident the improvements can be finished and paid for in time, because uncounted work creates a value shortfall and therefore taxable boot. Building in buffer — targeting completion well before day 180 — protects against the inevitable construction slippage.
Your qualified intermediary and CPA track which improvements count and ensure the value is properly credited. Documenting completion and payment within the window is essential for the improvements to count.
- An improvement exchange uses exchange funds to build or renovate the replacement within 180 days.
- An EAT holds title while the QI funds improvements; only work completed and paid for by day 180 counts.
- Construction risk is acute — realistic scopes and reliable contractors are essential.
Build-to-Suit Exchanges
A build-to-suit exchange is an improvement exchange used to construct a property (or substantial improvements) to your specifications. Rather than buying an existing property, you acquire land or a property and build what you want, using exchange funds, within the window.
Build-to-suit exchanges are powerful for investors who want a specific, custom replacement — a new building designed for a particular use or tenant — rather than an existing property. But they're also the most timeline-constrained, because new construction is harder to complete in 180 days than renovations.
These exchanges require careful feasibility analysis: can the construction realistically finish and be paid for within 180 days? If not, a build-to-suit improvement exchange may not work, and an alternative approach may be needed.
Can You Improve Property You Already Own?
A common question is whether you can use exchange funds to improve property you already own. Generally, no — you can't use a 1031 exchange to make improvements to property you already hold, because the replacement must be property you're acquiring, not property already in your possession.
There have been structures attempting to use related-party or leasehold arrangements to improve adjacent or related property, but these are aggressive, fact-specific, and risky. The standard improvement exchange involves an EAT acquiring and holding a new replacement property while it's improved.
If your goal is to improve property you already own, a 1031 exchange generally isn't the tool. Confirm any creative structure with experienced tax counsel before relying on it.
Common Use Cases
Improvement exchanges fit several situations. The most common is reaching equal-or-greater value when the best available replacement is priced below what you sold — improvements bridge the gap. Another is value-add investing, where you acquire an underimproved property and renovate it with exchange funds.
Build-to-suit construction for a specific use or tenant is another use case, as is completing improvements that a property needs to be functional or leasable. In each, the improvement structure lets exchange funds build value into the replacement.
These are sophisticated strategies best suited to experienced investors with reliable construction teams and realistic timelines. The improvement exchange rewards careful planning and punishes ambitious scopes that can't finish in 180 days.
Reverse-Improvement Combinations
An improvement exchange can be combined with a reverse exchange — a reverse-improvement exchange — when you need to both acquire the replacement before selling and improve it. The EAT acquires and holds the replacement, improvements are made with exchange funds, and you sell the relinquished property, all within the structure.
This is the most complex 1031 structure, combining the parking and financing challenges of a reverse exchange with the construction timeline of an improvement exchange. It's used in specific situations where both flips are necessary.
Because of the compounded complexity, reverse-improvement exchanges require highly experienced professionals and careful feasibility analysis. They solve a real but narrow problem, at a significant cost in complexity and expense.
Costs and Complexity
Improvement exchanges cost more than standard forward exchanges. You pay for forming and operating the EAT, additional legal and documentation work, and the coordination of construction disbursements through the QI — on top of the construction costs themselves.
The complexity is also higher: coordinating the EAT, the QI, the contractors, and the 180-day timeline requires careful project management. Delays or cost overruns can jeopardize the value that counts toward your exchange.
These added costs and complexity are the price of building value into a replacement within the exchange. Whether they're worth it depends on the value of reaching your target (or creating a custom property) versus the expense and risk.
Risks and Requirements
The central risk is construction timing: if improvements aren't completed and paid for within 180 days, the uncounted value creates boot, defeating the purpose. Permitting, weather, contractor, and supply delays all threaten the timeline, so conservative scoping and reliable contractors are essential.
Other risks include cost overruns (which can exceed your available exchange funds) and the added complexity of the EAT structure (which must follow the safe harbor precisely). Financing the construction and the parked property also requires planning.
The requirements, then, are a realistic, achievable construction scope; reliable contractors; sufficient exchange funds and financing; and experienced professionals (a QI skilled in EATs and improvement structures). Confirm feasibility — can the work finish in 180 days? — before committing.
A Worked Improvement Example
Suppose you sell for $1,000,000 but the ideal replacement is a property worth $750,000 as-is that needs $250,000 of renovations to be fully leasable and to reach your value target. You structure an improvement exchange: the EAT acquires the $750,000 property, and your QI disburses $250,000 of exchange funds for the renovations.
Over the next four months, the renovations are completed and paid for — comfortably within the 180-day window — bringing the property's value (and your exchange credit) to $1,000,000. Title transfers from the EAT to you, and the exchange completes with full deferral and no boot.
Because the renovations finished in time, the structure worked. Had $50,000 of the work remained incomplete at day 180, that $50,000 wouldn't have counted, creating boot. The example shows both the value of the improvement structure and the criticality of the construction timeline. Figures are illustrative.
Planning the Construction Timeline
Because the 180-day limit is the binding constraint, construction planning is the heart of a successful improvement exchange. Start by scoping only work that can realistically finish and be paid for well within 180 days — ideally targeting completion around day 150 to absorb the inevitable slippage in any construction project.
Line up your contractor before the exchange begins, with a clear scope, a fixed timeline, and ideally penalties for delay. Confirm that permits can be obtained quickly, that materials are available, and that the work isn't dependent on factors (like weather or long-lead items) that could push it past the deadline.
Renovations of an existing, functional property are far more achievable in 180 days than ground-up construction, so favor scopes that are improvements rather than full builds when the timeline is tight. If the work genuinely can't finish in 180 days, an improvement exchange may not be the right tool.
Throughout the project, track completion and payment against the 180-day clock, because only finished, paid-for work counts toward your replacement value. Building buffer and choosing reliable contractors with achievable scopes are the difference between an improvement exchange that fully defers and one that leaves uncounted value as taxable boot.
Financing the Improvements
Financing an improvement exchange has two components: acquiring the replacement property and funding the improvements. The acquisition is typically funded by your exchange proceeds (held by the QI), while the improvements are paid from exchange funds disbursed against completed work — but the timing of cash flow requires planning.
If your construction budget exceeds your available exchange funds, you may need additional financing or cash to complete the work, and any improvements you can't fund and finish within the window won't count toward your value. Aligning the construction budget with your available exchange proceeds is essential.
Some improvement exchanges involve a construction loan on the parked property, which the EAT structure must accommodate — another reason to use a QI and lender experienced with these exchanges. The financing must work with the EAT holding title during the improvement period.
The practical takeaway is to confirm, before you begin, that you have the funds (exchange proceeds plus any additional financing) to both acquire and improve the property to your target value within 180 days. A funding shortfall, like a timeline overrun, leaves uncounted value as taxable boot.
Improvement Exchanges and Value-Add Investing
Improvement exchanges are a natural fit for value-add investors — those whose strategy is to acquire underimproved properties and increase their value through renovation. The improvement structure lets a value-add investor use exchange funds to begin that value creation immediately, within the exchange itself.
For example, a value-add investor exchanging out of a stabilized property can acquire an underimproved replacement and use exchange funds to renovate it toward their target value, deferring the gain while executing their strategy. The improvement exchange aligns the tax structure with the investment plan.
The constraint, as always, is the 180-day window: only improvements completed in that time count, so the early phase of a value-add plan must fit the deadline. Larger value-add projects that extend beyond 180 days can complete the remaining work after the exchange, outside the 1031 structure.
For value-add investors who can execute meaningful improvements quickly, the improvement exchange is a powerful tool that combines tax deferral with active value creation. It rewards those with reliable construction capabilities and realistic, deadline-aware scopes — exactly the discipline value-add investing already demands.
Is an Improvement Exchange Right for You?
An improvement exchange is right when the best available replacement is worth less than what you sold (and improvements can bridge the gap), or when you want a custom build-to-suit replacement — and when the improvements can realistically be completed and paid for within 180 days.
It's not right for ambitious construction that can't finish in 180 days, for improving property you already own, or when a simpler approach (finding a fully-priced replacement, or a DST) would meet your needs. The construction timeline is the binding constraint.
Because improvement exchanges are specialized and timeline-critical, work with a qualified intermediary experienced in improvement and EAT structures, reliable contractors, your CPA, and an advisor who can assess feasibility and alternatives. Done right, an improvement exchange lets you build exactly the replacement you need while deferring the full gain.
Frequently Asked Questions
What is an improvement 1031 exchange?
A structure that lets you use exchange proceeds to build or renovate the replacement property, so the improvements count toward your equal-or-greater-value requirement. An exchange accommodation titleholder holds title and makes improvements while the qualified intermediary disburses funds, all within the 180-day window.
Why would I use an improvement exchange?
To reach equal-or-greater value when the available replacement is worth less than what you sold (improvements bridge the gap), or to create a custom build-to-suit replacement. It lets exchange funds build value into the property you've chosen rather than creating taxable boot.
Do improvements have to be finished within 180 days?
Yes. Only improvements completed and paid for within 180 days count toward the equal-or-greater-value requirement. Work in progress, uninstalled materials, or improvements finished after day 180 don't count, which can create boot.
How are construction funds held in an improvement exchange?
The exchange accommodation titleholder takes title to the replacement property, and your qualified intermediary disburses exchange funds to pay for construction as it's completed. Funds are released against finished, paid-for work, not pre-funded for the whole budget.
What is a build-to-suit exchange?
An improvement exchange used to construct a property or substantial improvements to your specifications, rather than buying an existing property. It's powerful for custom replacements but the most timeline-constrained, since new construction is harder to finish in 180 days.
Can I use exchange funds to improve property I already own?
Generally no. A 1031 exchange requires the replacement to be property you're acquiring, not property you already hold. The standard improvement exchange involves an EAT acquiring and holding a new replacement while it's improved. Aggressive structures to improve owned property are risky — consult tax counsel.
What counts toward my replacement value?
Only improvements actually completed and paid for within the 180-day window, plus the acquisition cost of the property itself. Work not finished and paid for by day 180 doesn't count, so build in buffer to ensure the value is credited.
What's the biggest risk of an improvement exchange?
Construction timing. If improvements aren't completed and paid for within 180 days, the uncounted value creates taxable boot, defeating the purpose. Permitting, weather, contractor, and supply delays all threaten the timeline, so realistic scopes and reliable contractors are essential.
Can I combine a reverse and improvement exchange?
Yes — a reverse-improvement exchange both acquires the replacement before selling (via an EAT) and improves it with exchange funds within 180 days. It's the most complex 1031 structure, combining parking, financing, and construction challenges, and requires highly experienced professionals.
How much do improvement exchanges cost?
More than standard forward exchanges — you pay for forming and operating the EAT, additional legal and documentation work, and the coordination of construction disbursements, on top of the construction costs. The complexity and project management are also greater.
What happens if construction runs past 180 days?
Any improvements not completed and paid for by day 180 don't count toward your replacement value, creating a shortfall that becomes taxable boot. This is why conservative scoping, reliable contractors, and targeting completion well before day 180 are critical.
Who do I need for an improvement exchange?
A qualified intermediary experienced in improvement and EAT structures, reliable contractors who can finish on time, your CPA, and ideally an advisor to assess feasibility and alternatives. The structure is specialized and timeline-critical.
Is an improvement exchange right for new construction?
Only if the construction can realistically be completed and paid for within 180 days. New construction is harder to finish in that window than renovations, so ambitious builds are poor candidates. Confirm feasibility before committing to a build-to-suit improvement exchange.
How does an improvement exchange avoid boot?
By using exchange funds to build value into the replacement so it reaches equal-or-greater value. Without the improvement structure, a value gap between a cheaper replacement and what you sold would be taxable boot; the completed improvements close that gap within the exchange.
Is an improvement exchange worth the complexity?
It depends on the value of reaching your target or creating a custom property versus the added cost, complexity, and construction risk. When a fully-priced existing replacement (or a DST) would meet your needs, that's simpler. The improvement exchange is for when building value into a specific replacement is genuinely necessary.
How early should construction finish in an improvement exchange?
Target completion around day 150, not day 180, to absorb the inevitable slippage in any construction project — permitting delays, weather, supply issues, or contractor problems. Only work finished and paid for by day 180 counts toward your replacement value, so buffer protects against uncounted work becoming taxable boot.
What if my construction budget exceeds my exchange funds?
You'll need additional financing or cash to complete the work, since improvements you can't fund and finish within the window won't count toward your value. Align your construction budget with your available exchange proceeds before you begin, or arrange a construction loan that works with the EAT structure.
Are improvement exchanges good for value-add investors?
Yes. Value-add investors — who acquire underimproved properties and renovate to increase value — can use exchange funds to begin that value creation within the exchange itself, deferring gain while executing their strategy. The constraint is the 180-day window, so the early phase of the plan must fit the deadline.
Can I finish improvements after the 180 days outside the exchange?
Yes — you can continue improving the property after the exchange completes, but that later work is outside the 1031 structure and doesn't count toward your replacement value. Only improvements completed and paid for within the 180-day window count, so plan the in-exchange scope to reach your value target by day 180.
Do I need a construction loan for an improvement exchange?
Sometimes. If the improvements cost more than your available exchange funds, a construction loan on the parked property can fund the gap — but the loan must work with the EAT holding title during the improvement period, which requires a lender experienced with these exchanges. Many smaller improvement exchanges are funded entirely from exchange proceeds.
Glossary
- Improvement Exchange
- A 1031 exchange using exchange funds to build or renovate replacement property within 180 days.
- Build-to-Suit Exchange
- An improvement exchange used to construct a property to the investor's specifications.
- Exchange Accommodation Titleholder (EAT)
- An entity that holds title to the replacement while improvements are made.
- Rev. Proc. 2000-37
- The IRS safe harbor governing improvement and reverse (parking) exchanges.
- Equal-or-Greater-Value Rule
- The requirement to acquire value at least equal to the relinquished property to fully defer.
- Boot
- Taxable value received, including replacement value not completed within the exchange window.
- 180-Day Window
- The period within which the acquisition and all counted improvements must be completed.
- Construction Disbursement
- Release of exchange funds by the QI to pay for completed, paid-for improvements.
- Reverse-Improvement Exchange
- A structure combining a reverse exchange with construction on the replacement.
- Parked Property
- The replacement property held by the EAT while improvements are made.
- Qualified Intermediary (QI)
- The party that holds exchange funds and disburses them for construction.
- Value-Add
- An investment strategy of improving an underimproved property to increase its value.
Sources & References
Disclosures
This article is published by Baker 1031 Investments, LLC for general educational purposes for accredited investors and is not an offer to sell or a solicitation of an offer to buy any security, nor is it tax, legal, accounting, or investment advice or a recommendation. Any securities offering is made solely through a sponsor’s private placement memorandum (PPM) following a suitability determination. Securities offered through Aurora Securities, Inc. (ASI), member FINRA / SIPC; Baker 1031 Investments is independent of ASI.
Oil & gas mineral and royalty interests and DST programs are speculative, illiquid securities sold only to verified accredited investors and involve substantial risk, including possible loss of principal, commodity-price and production-decline risk, lack of control, and the risk that an intended 1031 exchange fails to qualify for tax deferral. Whether a particular interest qualifies as like-kind real property is a fact-specific legal determination that varies by state and by the terms of the instrument. Tax results depend on your individual circumstances. Consult your own CPA and attorney before acting. Past performance does not guarantee future results.
