CRUT vs. 721 Exchanges: What Is the Difference?

For real estate investors, navigating the complexities of tax-deferral strategies and wealth optimization involves weighing the merits of various financial tools. Two widely discussed strategies, Charitable Remainder Unitrusts (CRUT) and Section 721 exchanges, offer compelling benefits. However, these options serve fundamentally different purposes and cater to distinct investor goals.

Understanding the differences between the various types of CRUTs and 721 exchanges is crucial for optimizing tax benefits, retaining control, and ensuring long-term financial growth. Follow this comprehensive guide to explore their mechanics, tax implications, and ideal use cases, ensuring you identify the best approach for your real estate investment strategy, which may include implementing both solutions.

Charitable Remainder Unitrust (CRUT) Explained

A Charitable Remainder Unitrust (CRUT) is a powerful estate planning and exit planning tool when selling highly appreciated real estate or other assets, such as privately held businesses or highly appreciated stocks.

The various types of CRUTs are designed to combine philanthropic intent with financial benefits, and you design the financial benefits that suit you and your family.

At its core, the CRUT is an irrevocable trust where an investor donates appreciated assets, such as real estate, to the trust. The donation generates an immediate tax deduction based on the present value of the future charitable contribution and is calculated based on IRS guidelines.

Once the donation is complete, the CRUT typically provides the donor (and potentially a beneficiary) with a steady income stream for a specified and flexible period based on the donor’s design. At the end of the period, which could be 50 years or more, the remaining assets transfer to the designated charitable organization.

Investors must understand the irrevocable nature of the trust arrangement, as donated assets are no longer under their direct control. Additionally, the payout percentages and administrative costs of establishing and maintaining a CRUT may not be suitable for all investors.

Section 721 Exchange Explained

Section 721 of the Internal Revenue Code introduces another tax-advantaged strategy focused on deferrals. Commonly used in the context of real estate, a 721 exchange involves contributing real estate property to a partnership or a Real Estate Investment Trust (REIT) in exchange for ownership units, rather than executing a traditional sale. In today’s climate, the best and most commonly used approach is to initially 1031 into a DST or Delaware Statutory Trust that in a short period of time converts to a REIT.

This strategy allows the investor to defer capital gains taxation, similar to the tax benefits of a 1031 exchange. The key distinction, however, is that a 721 exchange transitions ownership from direct realty to REIT or partnership units, while maintaining the deferred tax status. This enables investors to diversify their holdings, gain liquidity, and reduce management responsibilities without losing exposure to real estate as an asset class.

The flexibility of a 721 exchange lies in its ability to accommodate larger investors who wish to pool their resources within a portfolio of income-generating properties. However, this strategy comes with trade-offs, such as relinquishing control over the individually owned property and being subject to the decisions of the REIT or partnership managers.

Additionally, unlike the CRUT, a Section 721 exchange does not inherently incorporate charitable giving or income distribution for life.

Key Differences Between CRUT and 721 Exchanges

Identifying what the difference is between CRUT and 721 exchanges is critical before investing. While both CRUTs and 721 exchanges offer unique benefits to real estate investors, their goals and structures are vastly different.

Traditional CRUTs are ideal for investors with a philanthropic mindset who want to preserve long-term income and plan their estates strategically. They offer direct financial benefits like immediate tax deductions, deferred capital gains, and structured income. However, traditional CRUTs involve relinquishing ownership of the donated property, and they require ongoing trust administration, which can add complexity. There are variations to the traditional CRUT that allow flexibility as to when to receive income and for how long you can extend income and to whom.

On the other hand, a 721 exchange is a practical tool for tax deferral and diversification.

It is better suited for investors seeking to transform their property holdings into more liquid and diversified assets without an outright sale. Unlike the CRUT, a 721 exchange focuses on portfolio maximization rather than philanthropy. It lacks the advantages of income payout or charitable tax deductions, but it does receive a step-up in basis.

Tax implications also differ drastically. CRUTs help mitigate income tax liabilities through charitable deductions, while 721 exchanges primarily focus on deferring capital gains taxes. Furthermore, CRUTs involve additional tax considerations for beneficiaries, whereas 721 units can continue to appreciate under the management of the partnership or REIT.

Scenarios and Use Cases

Selecting between a CRUT and a 721 exchange often depends on an investor’s financial goals, asset appreciation, and personal values. This is why it’s important to consult experts in both CRUTs and 721 UPREIT exchanges who can help you navigate the process accurately. However, before talking to an expert, how do you narrow down whether you want to go the CRUT or 721 exchange routes?

Consider a real estate investor who believes in philanthropy and wants a steady income stream in retirement. By donating a highly appreciated property to a CRUT, they could defer immediate capital gains taxes, secure regular payouts, and ensure the remaining property value supports a charitable cause. This aligns with their dual desire to accomplish personal financial stability and create a significant societal impact.

Alternatively, an experienced investor with extensive holdings in multi-unit real estate might favor a 721 exchange. By contributing their property into a REIT through this mechanism, they avoid the logistical and financial toll of property management. Additionally, they shift their investment into a professionally managed, diversified portfolio that continues growing in value. This approach is ideal for those seeking flexibility and scalability without philanthropic aspirations.

Tax Implications and Considerations

Both CRUTs and 721 exchanges have unique tax implications that demand thorough evaluation. For CRUTs, the donor is eligible for an immediate charitable tax deduction when assets transfer into the trust. The amount of the deduction depends on the asset’s fair market value, the amount of income to the donor, the amount of time the donor expects income, and the expected value of the final charitable contribution.

Conversely, a 721 exchange helps defer capital gains tax indefinitely. By rolling over appreciated real estate into partnership or REIT units, investors minimize their immediate tax liability while enjoying long-term growth. As mentioned above, these distinctions highlight the importance of professional consultation. Both strategies require collaboration with tax advisors, attorneys, or financial planners to ensure compliance and optimize outcomes.

Evaluating the Right Strategy for Your Needs

Both the CRUT and the 721 Exchange present attractive opportunities for real estate investors to achieve financial efficiency and create tailored investment strategies. Deciding between them involves a careful assessment of your personal objectives, risk tolerance, and long-term financial goals.

Navigating these options can seem daunting, but you don’t have to make the decision alone. Start your journey today by scheduling your free consultation with Sera Capital. Professional guidance ensures your choices align with both your financial goals and IRS regulations. Explore the strategies and unlock the full potential of your real estate portfolio!