5 Things You Need To Know About 721 Exchanges
Carl E. Sera, CMT
March 9, 2023
A 721 exchange has similarities to 1031 exchanges, allowing investors to exchange appreciated real estate property for business or investment purposes. They work in operating partnerships that convert into shares of a real estate investment trust (REIT).
Any property allowing 721 exchanges to occur within the REIT can also work as a UPREIT. Should clients act upon a 721 exchange? Here are some things to know regarding 721 exchanges and if it’s the best course of action.
721 Exchange Functionality
A 721 exchange, or an UPREIT, focuses on an investor contributing property to REIT in exchange for units in an operating partnership. They are converted into shares of the REIT itself. This results in no taxes due to gains of the sale becoming deferred and no profit getting recorded.
As a result, clients provide by not worrying about substantial capital gains taxes while acquiring REIT shares. The only instances of taxing are when clients convert their OP units to common shares, which triggers taxable instances by the government.
Qualifications to Meet
Clients should know about meeting the qualifications of 721 exchanges. Most REITs target and require investments in institutional-grade real estate, as only some investors own these properties. They can’t directly contribute property to a REIT through a 721 exchange.
When incorporating a 1031 exchange, individual investors can exchange properties that don’t meet REIT criteria in a high-quality institutional-grade property for a fractional interest. Investors can contribute that interest to a REIT in a tax-deferred 721 exchange.
Offers Passive Income
Something to know regarding 721 exchanges is the benefits they offer. Mainly, 721 exchanges create opportunities for passive income due to being REIT shareholders.
Managers oversee the operation of REITs and handle their assets, allowing investors to have a hands-off approach while managers take care of the day-to-day decision-making. Because managers take the heavy work, investors communicate distributions, acquisitions, and dispositions.
Provides Tax Advantages
Because of the 721 exchange structure, property gains on a sale become deferred. Typically, sales gains realized in a deal would be subject to tax. This tax, along with the tax on depreciation used to offset property taxes, can exceed 25 percent of the gains received upon sale.
As a result, this leaves investors with substantially fewer capital amounts that can contribute toward another investment. With a 721 exchange, investors can defer costly taxes and use all the gains on sale toward purchasing shares in a REIT.
What To Avoid
Every client should know about a potential downside: the inflexibility of investment. With 721 exchanges, clients can’t perform another deferred tax exchange after receiving REIT shares.
Unlike flexible 1031 exchanges, REIT shares are not eligible for use in other deferred tax exchanges. Investors must take great care in choosing a REIT with long-term work availability to avoid any regret.
Sera Capital offers highly-professional, helpful 721 tax deferred exchange services and advice to eager clients. Schedule a 30-minute phone call with us today for more information.