October 16, 2023
What is a 721 Exchange and How Does it Work?
Many real estate investors are familiar with a 1031 tax-deferred exchange, which allows an investor to defer paying taxes on the gain resulting from a sale of real estate. The investor must reinvest the proceeds in a qualifying like-kind property within a defined time period to defer the tax. Deferring taxes can be a high priority for an investor with a low tax basis in a property. The 1031 Exchange has a long history after originally being introduced into the tax code via the Revenue Act of 1921. The 721 Exchange, is a lesser-known alternative, but can also be a useful tool for a real estate investor to manage their tax burden and real estate investments.
Instead of selling a property for cash or exchanging for another property, in a 721 Exchange, an investor can contribute ownership of a property (or “sell”) to a partnership in exchange for a partnership interest or shares in the partnership. Similar to a 1031 Exchange, this transaction allows an investor to defer capital gains or depreciation recapture. Upon selling the property and receiving an ownership interest in the purchasing company, the seller becomes a passive owner.
There are several rules that a seller must consider when doing a 721 Exchange that include, how and when distributions are made, how long the seller must hold their ownership interest in the purchasing company, and how long the buyer should hold the property as an investment. Violating any of those rules could result in re-accelerating the capital gains tax the seller was attempting to defer. Any seller considering a 721 Exchange should consult a tax professional for more detailed advice.
In order for a 721 Exchange to work, the transaction must fit the investment parameters of each party. For the seller, they must determine if the purchasing company is a suitable investment to take the place of the property they plan to sell. For the buyer, they must decide if the property they are purchasing fits well into their existing portfolio and their strategic plan.
As a private real estate investment partnership, Investors Associated, LLP (“IA”) can offer sellers the opportunity to exchange property for IA partnership units and defer capital gains tax via a 721 Exchange. In fact, we completed a 721 Exchange for an industrial property in Northern Colorado in July of 2023.
At IA, we believe in a diversified approach to real estate investment and we have been able to utilize various tax strategies to grow our portfolio to the benefit of our investors. To learn more about the property selection process here at Investors Associated, LLP, please reach out to Jamie Stefan, Sr. VP of Investor Relations at (414) 797-3947 or [email protected].