Episode 70 of the Construction Accounting Podcast with George Ghazarian, CPA · 5 min 52 sec · Published 7 January 2026

Most people treat a 1031 exchange as selling one finished property and buying another. There is a version that heavily favors contractors, builders and developers, and most investors do not know it exists. It is called an improvement exchange, or a construction 1031 — and it lets you stop being a passive buyer of property and start manufacturing your replacement property instead.

What you’ll learn

  • How an improvement exchange differs from a standard 1031
  • Why construction costs can count toward replacement value
  • A worked example with real numbers
  • The three advantages contractors have that other investors do not
  • The structural rule you cannot get wrong

A quick recap of the standard rules

A 1031 exchange lets you sell investment or business property and defer capital gains tax, provided you reinvest into qualifying replacement property within strict IRS timelines:

  • It must be investment or business property
  • 45 days to identify the replacement
  • 180 days to close
  • Funds held by a Qualified Intermediary

Most people stop there. Contractors should not.

What an improvement exchange is

With an improvement exchange you can sell your old property, buy a fixer, raw land or a partially improved property, use exchange funds to construct or renovate, and have those improvements count toward your replacement value.

Put another way: the IRS allows you to roll your gains into future value, not just what exists on day one.

Why that matters for deferral

To fully defer, your replacement property must be equal or greater in value, equal or greater in debt, and you must reinvest all net proceeds.

But what if the deal you actually want needs work, is underbuilt, or is raw land? An improvement exchange lets you reach the required value over the exchange period rather than on day one. Construction costs paid with exchange funds count toward replacement value, as long as the work is completed within the 180-day window. That is the key mechanic.

A worked example

Say you sell a property for $2,000,000, with $1,200,000 of taxable gain. You identify a rundown commercial building at $1,400,000.

Normally that fails — the replacement is too cheap. But instead you allocate $600,000 of exchange funds to improvements: structural upgrades, tenant improvements, build-outs.

As long as the money is spent before day 180, and the work is completed while the exchange structure still holds title, you end up with a $2,000,000 replacement property and full deferral.

Why contractors have an unfair advantage

This strategy is difficult for ordinary investors. For a contractor it is almost unfair.

Cost control

You build at cost, not retail. Every dollar saved increases equity, improves cash flow and reduces risk.

Speed

Permits, subcontractors and sequencing are what kill most improvement exchanges. You already know who to call, what to prioritize and what can realistically be finished inside 180 days.

Designing for the tax strategy

You can front-load qualifying improvements, focus on the value drivers the IRS recognizes, and avoid spending exchange funds on items that will not qualify.

The structure most people get wrong

This is the part you cannot mess up. In an improvement exchange:

  • You personally cannot own the property during construction
  • A special entity, usually an Exchange Accommodation Titleholder, temporarily holds title
  • Improvements must be completed before title transfers to you

Which is why this needs a sophisticated Qualified Intermediary, a CPA who understands construction, and proper legal coordination. It is not a do-it-yourself strategy.

Where these fall apart

  • Planning too late. A construction exchange has to be planned before the sale closes.
  • Over-scoping the project. If it cannot be completed in 180 days, it does not count.
  • Assuming all costs qualify. Soft costs, design and certain items may or may not — the detail matters.
  • Using advisers who have never done one. If your CPA says “I think”, stop.

The short version

  • An improvement exchange lets construction costs count toward replacement value
  • You can reach the required value over 180 days, not on day one
  • Contractors build at cost and control the schedule — the two things that kill these deals
  • Title must sit with an Exchange Accommodation Titleholder during construction
  • It must be planned before the sale closes, not after

Want this applied to your numbers?

We are a CPA firm built for construction contractors. If you want to know what this looks like against your actual profit, salary and job mix, we will run it with you.

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This episode is general information about how these rules work, not advice for your situation. Tax law changes and the right answer depends on your entity, your income and your circumstances. Talk to a CPA before acting on it.