1031 Exchange into Self Storage facility + Material to Expand?

Question

I'm working on selling a 10 unit multi family and buying 2 self storage facilities on a 1031. Can I use some of the cash to buy materials to add more units at one of the facilities? Trying to find a way to use all the 1031 exchange money.

Dave Foster · Answer

@Kyle Daneff, You'd be looking at an "improvement exchange".  You cannot exchange into improvements on property you own.  But in an improvement exchange the 1031 intermediary takes title to the new property and holds it while you improve it.  You can use your 1031 proceeds for the purchase by the QI and the improvements.  And you are totally in control and making the income from the new property while the QI holds it for up to 180 days.

The two real issues with an improvement exchange are

1. Financing - If you are using financing for the purchase it will not be a conventional product.  It will have to be a private or portfolio lender like a local bank.  Sometimes this is a little more expensive.  And it many times takes some education for the lenders.

2. Cost/complexity of the exchange - These will add several thousand dollars to the typical 1031 fee.  So you want to make sure that your gain and deferred tax justifies the cost.

Another option would be to use all of the proceeds from the sale in the purchase ((even if it means overfunding the down payment significantly).  Once the 1031 is complete then do a cash out refinance.  The cash generated in this is not taxable and can be used as you wish in the improvement of the new property.