Advancing 721 Exchanges Through Education, Advocacy, and Collaboration

What is a 721 Exchange

A 721 exchange, named after Section 721 of the Internal Revenue Code, allows real estate owners to contribute their property to a real estate investment entity—typically a Real Estate Investment Trust (REIT) or a private real estate fund structured as a limited liability company (LLC)—in exchange for an ownership interest in the entity. When executed correctly, this strategy provides several key benefits:

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•    Tax Deferral on Capital Gains – Similar to a 1031 exchange, a 721 exchange allows investors to defer capital gains taxes when transitioning from direct         property ownership to fund ownership.

•    Diversification – Instead of being tied to a single property, investors gain exposure to a professionally managed portfolio of real estate assets.

•    Passive Investment – Investors move from actively managing properties to a more hands-off approach, benefiting from professional asset                                 management.

•    Estate Planning Advantages – Ownership interests in a REIT or real estate fund can simplify inheritance and wealth transfer compared to direct                     property ownership.

A useful way to think about a 721 exchange is by comparing it to a mutual fund. A mutual fund pools together a diversified portfolio of stocks or bonds, managed by professionals with the goal of optimizing returns. Instead of holding just one stock, investors in a mutual fund benefit from exposure to hundreds of different companies, reducing risk through diversification.

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Similarly, a 721 exchange allows real estate owners to trade a single, undiversified property for an interest in a diversified real estate portfolio, managed by professionals who oversee acquisitions, leasing, and asset performance. This transition offers greater liquidity, reduced risk, and ongoing income potential while deferring taxes on the initial exchange.

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Understanding the Structure

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Before proceeding with a 721 exchange, it's crucial to recognize the differences between publicly traded REITs and private real estate funds:

•    Publicly Traded REITs – These offer liquidity similar to stocks, allowing investors to buy and sell shares easily. However, once real estate is contributed         to  a REIT, it generally cannot be exchanged back into individual property ownership.

•    Private Real Estate Funds – These funds may have longer lock-up periods or limited redemption options, meaning investor capital could be tied up for       years. However, they often provide higher potential returns and more direct exposure to real estate assets.

Additionally, while 721 exchanges defer capital gains taxes, they do not provide the ability to perform another 1031 exchange in the future. Once a property is converted into REIT or fund shares, the tax benefits of like-kind exchanges are no longer available.

Who Should Consider a 721 Exchange?

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A 721 exchange is an excellent strategy for:

• Property owners seeking diversification – Moving from a single-asset investment to a professionally managed real estate portfolio reduces concentration risk.

• Investors transitioning into retirement – Passive ownership eliminates the burden of property management while maintaining real estate exposure.

• Those focused on estate planning – Passing down shares in a REIT or real estate fund is often simpler than transferring physical property.

• Long-term investors looking for income and appreciation – REITs and funds typically generate rental income while benefiting from property value appreciation over time.

Conclusion

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A 721 exchange offers a powerful strategy for real estate investors looking to transition from direct property ownership into a diversified, professionally managed portfolio—while deferring capital gains taxes. However, investors should carefully evaluate the structure, liquidity, and long-term implications before proceeding.