Understanding the 721 Exchange: How to Potentially Defer Taxes and Boost Your Real Estate Portfolio
Please note this content is for informational purposes only. Please always consult your tax advisor.
Many in the real estate world have heard about something called a “721 Exchange.” It might sound complicated, but it’s actually a straightforward and powerful strategy to possibly defer taxes for some while transitioning real estate holdings into a diversified and professionally managed portfolio.
So, What Exactly is a 721 Exchange?
Simply put, a 721 Exchange allows a property owner to contribute a property directly into a Real Estate Investment Trust’s (REIT) Operating Partnership (OP). Instead of selling the property and paying capital gains taxes right away, they can receive units in the Operating Partnership, known as OP units. This means they can potentially avoid immediate taxes and still maintain an investment stake.
How Does a 721 Exchange Work?
Let’s Break it Down:
-
Contribute the Property
The property owner transfers ownership of their property directly into the REIT’s Operating Partnership. In return, they get OP units—think of these as shares representing their ownership stake in the REIT’s entire portfolio. Tax benefit: No immediate capital gains taxes at this point
-
Option to Convert Units into REIT Shares
Later on, they have the flexibility to convert their OP units into REIT shares. This conversion typically doesn’t trigger immediate taxation either. It allows them to diversify further and have access to liquidity through publicly traded shares.
-
When do you Pay Taxes?
Taxes are deferred until they decide to sell their OP units or the REIT shares for cash. Only then are the deferred capital gains taxes triggered.
-
Estate Planning Perks
One major bonus: if they hold onto those OP units, their heirs could receive a tax advantage known as a step-up in basis. This can reduce or potentially eliminate future capital gains taxes.
What Makes a 721 Exchange Appealing?
Tax Deferral:** Keep their money invested longer instead of paying immediate taxes.
Potential Liquidity and Flexibility: Convert OP units into REIT shares, allowing the investors to participate in the REIT redemption plan (if available) or the public market in the case of a public REIT. 1
Diversification: Reduce your investment risk by becoming part of a professionally managed, diversified real estate portfolio.
Professional Management: Leave the property management headaches to the pros.
Legacy Planning: Benefit heirs through tax savings.
Important Things to Keep in Mind:
While a 721 Exchange has many upsides, remember:
Ready to get started or need to ask a question about the 721 Exchange process?
1 Distributions are not guaranteed. The actual amount and timing of distributions to the investors may be determined based on financial condition and other market factors.
Resources:
IRS Section 721 (https://www.law.cornell.edu/uscode/text/26/721)
IRS Publication 541 – Partnerships](https://www.irs.gov/publications/p541)
Nareit Overview of 721 Exchange (https://www.reit.com/data-research/research/section-721-exchange)
This content has been prepared for information purposes only and is not intended to constitute tax advice. You should not, therefore, interpret any statements in this email to be tax advice or rely on the statements for such a purpose. You should consult your own tax and financial advisors before engaging in any transaction.
Securities of CalTier REIT I, Inc. are offered through North Capital Private Securities, a member of FINRA/SIPC. Private investments are highly speculative, illiquid, may involve a complete loss of capital, and are not suitable for all investors.
