Yes, you can use a 1031 exchange for new construction. It’s called a build-to-suit or improvement exchange: you sell an investment property, the proceeds are held by a qualified intermediary, and they’re used to buy land and construct a new building that becomes your replacement property. The catch is that you cannot hold title to the construction site yourself while the work is happening, and the building has to be far enough along within 180 days of your sale to absorb the money you’re trying to defer tax on.
How a Build-to-Suit Exchange Works
Section 1031 of the Internal Revenue Code lets you defer capital gains tax when you sell real property held for business or investment use and replace it with property of “like kind.”1Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment Like-kind is broad in real estate. Raw land, apartment buildings, warehouses, retail space, and office buildings all qualify as like-kind to one another, which is what makes construction exchanges possible in the first place: you can sell a rental and use the money to put up something entirely new on vacant land.
Both the property you sell and the one you receive have to be held for investment or business use. Your primary home doesn’t qualify. Neither does property held as inventory, such as a house a developer builds specifically to resell, because the IRS treats that as stock in trade rather than an investment.1Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment The IRS looks at your intent at the time of the transaction, so a short-term flip generally won’t work.
Done properly, the exchange defers capital gains tax, the 3.8% net investment income tax that can apply to higher earners, and depreciation recapture of up to 25% on any depreciation you previously claimed.2Internal Revenue Service. Topic No. 409, Capital Gains and Losses3Internal Revenue Service. Net Investment Income Tax All of those dollars stay in the new project.
Why You Can’t Build on Land You Already Own
Here is the trap that surprises most first-time users of this strategy: you cannot build on land you already hold in your own name. The IRS treats improvements you make to your own land as buying construction services, not acquiring replacement real estate. Section 1031 requires you to receive property from someone else, so improving your own dirt doesn’t count.
The workaround is an Exchange Accommodation Titleholder, or EAT, that takes and holds title to the land while the building goes up. Revenue Procedure 2000-37 provides a safe harbor for this setup. As long as the deal is structured as a Qualified Exchange Accommodation Arrangement (QEAA), the IRS treats the EAT as the owner for tax purposes, and the land plus the improvements are treated as a single replacement property that the EAT eventually deeds to you.4Internal Revenue Service. Rev. Proc. 2000-37
The sequence typically looks like this: the EAT takes title to the vacant land, construction happens while the EAT holds it, and the completed (or partially completed) property is deeded to you before the 180-day deadline. You do not hold legal title to the construction site at any point during the build.
The 45-Day Identification Window
The clock starts on the day you close the sale of your old property. Within 45 days, you must identify the replacement property in writing and deliver that identification to a qualified party such as the seller or your qualified intermediary. Written notice to your attorney, accountant, or real estate agent doesn’t satisfy the rule.5Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
In a construction exchange, identifying the land isn’t enough. You have to describe the improvements you plan to build in enough detail that the IRS can see a “uniquely identifiable” property. A legal description of the lot combined with specifics like “a 2,500-square-foot retail building at the southwest corner of Lot 14” works. Vague language like “a new building” can void the whole exchange on audit. Attaching blueprints, site plans, or construction specs strengthens the identification.
Once the 45 days close, you cannot change or add to what you identified. That means budgets, permit applications, and contractor agreements should already be moving before you sell the relinquished property. Waiting to figure out the details after the sale rarely leaves enough runway.
The 180-Day Completion Deadline
You must receive the replacement property no later than 180 days after selling the relinquished property, or by the due date (with extensions) of your tax return for the year of the sale, whichever comes first.5Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031 Sell in late December and file on April 15 with no extension, and your real deadline may be well under 180 days. Filing an extension is a routine way to preserve the full window.
The 180 days run from the sale date. They are not added onto the end of the 45-day identification period; both clocks start together. And the property you actually receive has to be “substantially the same” as what you identified, so major design changes mid-project create risk.
There are no extensions for construction delays, permit holdups, material shortages, or weather. In a build-to-suit exchange, keeping the project on schedule is a tax-compliance issue.
What Happens if Construction Isn’t Finished in Time
If the building isn’t done at day 180, you still take title to whatever exists. Only the fair market value of the land plus improvements completed by that date counts toward your replacement property value. Any shortfall between that value and the net sale price of the property you sold is treated as “boot,” and boot is taxable.
Say you sold for $1 million and, at day 180, the land plus partially completed building is worth $750,000. You owe capital gains tax on the $250,000 gap. Exchange funds still sitting in the QI’s account at that point are returned to you and taxed as well, and depreciation recapture of up to 25% on the relinquished property comes due too.
Taking control of the exchange proceeds before the deadline, even briefly, can blow up the entire exchange and make all of the gain immediately taxable.5Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031 Every dollar of construction funding should move through the QI or the EAT, never through your personal accounts.
Cost, Debt, and Insurance
Construction exchanges cost meaningfully more to administer than standard ones. A typical deferred exchange runs roughly $600 to $1,500 in QI fees. An improvement exchange with an EAT often runs $7,500 to $15,000 or more because of the extra entity setup, documentation, and monitoring.
State transfer taxes can hit twice: once when title moves to the EAT and again when it moves from the EAT to you. Rates range from nothing in some states to as much as 3% of property value in others, so on a high-value project this double hit can be substantial.
Debt is the other planning hurdle. If your old property had a mortgage, you generally need to replace that debt on the new property, or bring cash to cover it, to avoid the paid-off loan being treated as boot. Many construction lenders are not set up to lend to an EAT. Some won’t do it at all. Those that will typically require your personal guarantee, and the EAT will insist the loan be non-recourse to itself. If a third-party construction loan is involved, you generally assume it when title transfers to you at closing. Get lender approval before you start the exchange; discovering mid-project that your lender won’t work with the EAT structure can wreck the timeline.
Budget for builder’s risk insurance (sometimes called course-of-construction insurance) covering the building, materials, and equipment during the build. Name both the EAT and the contractor on the policy, with you as an additional insured. Confirm general liability and workers’ compensation coverage for contractors and subcontractors before any work starts.
Buying Land From a Related Party
Buying construction land from a related party is allowed but heavily scrutinized. Section 1031(f) imposes a two-year holding rule: if you or the related party disposes of the exchanged property within two years, the tax deferral is retroactively disqualified. The statute also bars exchanges structured as part of a series of transactions designed to work around the rule.1Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
Related parties include family members (siblings, spouses, ancestors, and lineal descendants) and entities in which you own more than 50%. If your project involves land leased from a related partnership rather than purchased, IRS guidance requires the lease to be at arm’s length, including a term of more than 30 years and fair market rental rates, to keep QEAA treatment.6Internal Revenue Service. Private Letter Ruling 202520001
Mixed-Use Projects
If your project will include personal-use space, such as a unit you plan to live in inside a building otherwise held for rental, only the investment portion qualifies. You allocate the sale price and expenses proportionally, and only the investment share enters the exchange. Support the allocation with documentation like square footage or appraised values.
Where the relinquished property was also your primary residence, the personal-use portion may qualify for the Section 121 capital gains exclusion (up to $250,000 for single filers, $500,000 for married couples filing jointly). Revenue Procedure 2005-14 covers how to combine Sections 121 and 1031 in the same transaction.
Reporting the Exchange and Your New Basis
You report the exchange on IRS Form 8824 for the tax year it occurred. Parts I, II, and III capture the relinquished and replacement property details, any boot, and the recognized gain.7IRS.gov. 2025 Instructions for Form 8824 – Like-Kind Exchanges Recognized gain such as boot from unfinished construction flows to Schedule D, Form 4797, or Form 6252 depending on the situation. If you disposed of depreciable real property (Section 1250 property), part of the gain may need to be recaptured as ordinary income on Form 8824, line 21.
Your basis in the new property isn’t its fair market value. It’s the basis from the property you gave up, adjusted for any boot paid or received. This carryover basis preserves the deferred gain for the day you eventually sell in a taxable transaction.5Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031 Practically, that means your depreciable basis on the new building will be lower than if you had bought it outright, which shrinks the annual depreciation deduction going forward.
When the EAT deeds the finished property to you before day 180 and the deed is recorded, the exchange is complete. Keep the QI’s final accounting statement with your permanent tax records; it’s the foundation for your basis calculation and your best defense if the exchange is ever audited.