Exchanging Into Improvements on Exchanger’s Own Land

By: Michael Wiener

Clients often ask whether they can construct improvements on land they already own as replacement property in their exchange. As demonstrated by a recent IRS private letter ruling,[1] with enough advance planning, it may be possible. [2]

The taxpayer in the ruling was a limited partnership that owned vacant land. The taxpayer planned to contribute the land to a partnership that it would form with an affiliate.  The partnership and the taxpayer would be related parties for purposes of Section 1031.

More than 180 days after the land was contributed to the partnership, an LLC that was wholly-owned by the taxpayer’s exchange accommodation titleholder (the “EAT”) would enter into a ground lease with the partnership for the land.  The lease would have a term of more than 30 years, contain arm’s length terms, including fair market value rent, and permit the LLC to construct improvements on the land.  The LLC would construct the improvements in accordance with the taxpayer’s specifications.

At some point (presumably on or around the lease date), the taxpayer would sell its relinquished property through a qualified intermediary as part of a deferred 1031 exchange.  The LLC would use the proceeds from the sale of the relinquished property, together with funds loaned by the taxpayer and its affiliates, to pay rent due under the ground lease and the costs of constructing the improvements. Within 180 days following the lease date, at the direction of the taxpayer’s qualified intermediary, the EAT would transfer its 100% membership interest in the LLC to the taxpayer as replacement property in the taxpayer’s 1031 exchange.  Importantly, the partnership and the taxpayer agreed that neither party would dispose of the land (in the case of the partnership) or the replacement property (in the case of the taxpayer) within two years of the completion of the exchange.

In ruling for the taxpayer, the IRS found that the exchange did not violate the related party exchange rules since (i) the taxpayer’s exchange was with the qualified intermediary (who is not a related party to the taxpayer), not the partnership, and (ii) neither of the related parties cashed out for two years following the exchange.  In addition, the fact that the partnership, and not the taxpayer, owned the property for more than 180 days before entering into the ground lease with the EAT allowed the transaction to qualify for the parking exchange safe harbor under IRS Revenue Procedure 2000-37.[3]

The ruling highlights two points regarding the contribution of the land to the partnership.  First, the ruling emphasizes that, from and after the contribution, the partnership, and not the taxpayer, had the benefits and burdens of ownership of the land and, therefore, was the tax owner of the land.  In addition, the ruling emphasizes that the taxpayer had a separate, non-tax reason for making the contribution.  Specifically, the taxpayer wanted to separate the partnership’s ground leasing activities from the taxpayer’s other real estate operations.  By emphasizing these points, the ruling makes it clear that the contribution to the partnership had independent substance.

The structure described in the ruling requires significant advance planning to execute.  However, in the right circumstances, it can be very useful for taxpayers when structuring their 1031 exchanges.

[1] PLR 202520001, which was released on May 16, 2025.

[2] A private letter ruling is directed only to the taxpayer that requested it and cannot be cited as precedent.  However, despite their non-precedential status, private letter rulings can provide valuable insight into the IRS’s thinking on a particular issue.

[3] Taxpayers often use the safe harbor provided by Revenue Procedure 2000-37 when engaging in either a reverse exchange or an improvement exchange.  In Revenue Procedure 2004-51, the IRS provided that the safe harbor does not apply if the taxpayer owns the replacement property within the 180 day period prior to the date when the exchange accommodation titleholder acquires it.

The materials and content provided on this website are for general informational purposes only. These materials and content do not, and are not intended to, constitute legal, tax, or financial advice.