A 721 Exchange, also known as an “UPREIT” (Umbrella Partnership Real Estate Investment Trust) transaction, is a tax-deferred exchange that allows property owners to contribute their real estate into a Real Estate Investment Trust (REIT) in exchange for operating partnership (OP) units in that REIT, rather than selling the property outright. Obviously, this is only going to work for those investors who currently own investment property that would be desired by a REIT.
This exchange is named after Section 721 of the Internal Revenue Code, which governs this kind of transaction.
Here’s how a 721 Exchange works:
- Contribution to the REIT: Instead of selling their property for cash, the property owner contributes it to the REIT’s operating partnership (often called the OP). In return, they receive OP units, which function similarly to shares in the REIT.
- Tax Deferral: The property owner can defer the capital gains taxes they would have otherwise paid if they had sold the property outright. This is similar to the tax-deferral benefit of a 1031 Exchange, where capital gains taxes are deferred until a future taxable event occurs.
- Diversification and Liquidity: OP units are exchangeable for REIT shares after a holding period (usually one year or more, depending on the specific REIT), and the property owner can eventually convert these OP units into REIT shares. By doing so, they achieve increased liquidity and a diversified portfolio of properties. Converting OP units to REIT shares may be a taxable event, but the advantage of diversification into a larger, professionally managed portfolio often outweighs the tax hit.
- Access to REIT Benefits: By participating in an UPREIT structure, the original property owner gains access to the benefits of being part of a larger REIT, such as income from a diversified portfolio, professional property management, and participation in the broader commercial real estate market.
Benefits of a 721 Exchange:
* Tax Deferral: Like a 1031 Exchange, the property owner defers paying capital gains taxes when contributing to the REIT.
* Diversification: Instead of owning a single property, the property owner receives shares or OP units in a diversified portfolio of assets held by the REIT.
* Liquidity: OP units can eventually be converted into REIT shares, which can be traded more easily than selling a real estate asset.
Considerations and Limitations:
Non-Taxable Event Initially: The contribution of property to the REIT in exchange for OP units is a non-taxable event. However, converting OP units to REIT shares is typically a taxable event.
No Direct Ownership: Once you contribute the property to the REIT, you no longer own the property directly. The REIT’s management decides what happens to the properties within its portfolio.
REIT Regulations: REITs must comply with strict IRS regulations to maintain their tax advantages, which could affect distributions or investment strategy.
A 721 Exchange is particularly attractive for real estate investors looking to transition from active property management to a passive income stream and for those seeking to diversify their real estate holdings without triggering immediate capital gains taxes.
There is a similar product that can be exchanged to through a normal 1031 exchange that is available through a couple of the larger, more well-known institutional DST providers and it is also referred to as an UPREIT.
The difference is that once the investor sells the relinquished property, they would identify and exchange into one of the noted sponsors DST that after a minimum of two (2) years, “rolls up” into a REIT where now the investor can liquify shares as explained above. Everything else is the same, especially when they liquidate any shares, as that triggers a taxable event, and they will be subject to the original tax rate on the original capital gain.
We Are to Help!
If you are an investment property owner who is interested in a no obligation, private consultation, please visit www.Best1031Online.com, or contact James Bean
of SVN-Rich Investment Real Estate Partners, CA DRE# 01970580, at 805-779-1031
or email at [email protected].
If you are an agent/broker, I am happy to discuss strategies with you on how to best serve your next listing client in preparing them for a successful exchange. Please visit the site and click on the Agent’s button located at the top right-hand corner of the Home Page!
Don’t know what certain terms mean?
Click here for a Glossary of Terms: https://svn-best1031online.com/glossary/
Want more on the 1031 Exchange?
Come join me on my YouTube Channel “Best 1031 Online”
The ONLY channel 100% dedicated to all things 1031!
And visit CRE Task Wizard at https://cretaskwizard.com/, who supports me in making the channel happen.
Please stay tuned and follow me on LinkedIn, X (formerly known as Twitter), Instagram, & Facebook @1031BrokerJames.
All information is deemed to be accurate and is not tax or legal advice. All investors/taxpayers should consult their CPA, tax attorney and investment advisors.