The main obstacle in this type of 1031 exchange is that the Exchanger cannot take title to the replacement property. The QI must take title to the property while the improvements are being done. When there is a lender involved, issues may arise as a result of the QI holding title to the property. In most cases they can be overcome and a successful exchange can be accomplished.
If a taxpayer intends to leverage replacement property immediately after an exchange, the taxpayer should make certain that the debt in fact is not incurred until after the exchange. As a practical matter, this means that the debt financing should be evidenced by a separate closing with a separate settlement statement from the title company. Although the acquisition and the financing can occur in back-to-back transactions, the two transactions should be distinct and separate, and title to the replacement property should be clearly vested in the taxpayer before debt is placed on the property. To be certain that these timing requests are met, tax advisors frequently arrange for the debt to be placed on the replacement property the day after it is acquired.