721 Exchange Frequently Asked Questions (FAQs)

The 721 exchange is a nuanced tax-deferral strategy often utilized by real estate investors to transition from direct property ownership into a more diversified and liquid investment in a Real Estate Fund.

This method offers numerous advantages, including potential tax benefits, estate planning efficiencies, and a shift towards a hands-off investment approach.

Below, we delve into some of the most commonly asked questions regarding the 721 exchange process, specifically focusing on exchanges involving Real Estate Funds rather than REITs, to provide clarity and insight into how this strategic move can benefit investors.

1. What is a 721 exchange?

A 721 exchange, also known as an UPREIT transaction, allows real estate property owners to contribute their property to a Real Estate Fund in exchange for operating partnership units in the Fund, on a tax-deferred basis.

2. How does a 721 exchange work?

Property owners contribute real estate to a Real Estate Fund in exchange for operating partnership units (OP units), which can later be converted into shares of the publicly traded Fund. This transaction can defer capital gains taxes until the OP units are converted into Fund shares and those shares are sold.

3. What are the benefits of a 721 exchange?

Benefits include diversification, as the seller gains access to a broader portfolio of properties; liquidity, since OP Units may be converted into publicly traded Fund shares; and potential estate planning advantages, allowing for a step-up in basis for heirs without capital gains and depreciation recapture taxes.

4. Are there any tax advantages to a 721 exchange?

Yes, a key advantage is the deferral of capital gains taxes. Taxes on the gain from the contributed property are deferred until the OP Units are converted and the Fund shares are sold.

5. Can any type of real estate be exchanged through a 721 exchange?

Most types of real estate can be contributed in a 721 exchange, but it is crucial to consult with a tax or financial advisor to ensure the specific property qualifies.

6. Can an investor perform a 1031 exchange after a 721 exchange?

Once a 721 exchange is completed, and the investor has received Fund shares, those shares cannot be used in a 1031 exchange. Thus, capital gains taxes can no longer be deferred via a 1031 exchange after completing a 721 exchange.

7. Can DST (Delaware Statutory Trust) interests be used in a 721 exchange?

Yes, property owners can contribute DST interests to a Real Estate Fund as part of a 721 transaction, with taxes on the transaction deferred while the OP Units are held.

8. How does a 721 exchange differ from a 1031 exchange?

While both transactions allow for tax deferral on capital gains, a 721 exchange involves contributing property to a Real Estate Fund in exchange for OP units, leading to indirect ownership in a diversified portfolio. A 1031 exchange involves swapping one investment property for another like-kind property directly.

9. What are the risks involved in a 721 exchange?

Risks include changes in market conditions that can affect the value of the Fund's portfolio, liquidity risks associated with converting OP Units to Fund shares, and potential tax liabilities if the exchange is not structured properly.

10. Who should consider a 721 exchange?

Investors looking for diversification, liquidity, and tax deferral benefits, especially those aiming for a more passive investment strategy or estate planning, may find a 721 exchange appealing. However, due to its complexity, it's advised to consult with financial and tax professionals.

11. Is there a time limit within which a 721 exchange must be completed?

Unlike the 1031 exchange, which has strict timing rules, the 721 exchange does not have specific time limits for completion. However, coordinating with a Real Estate Fund and meeting their requirements can influence the timeline.

12. Can an investor combine a 1031 exchange with a 721 exchange?

Yes, investors may first utilize a 1031 exchange for like-kind property and later transition to a 721 exchange by contributing the acquired property to a Real Estate Fund, providing a pathway from direct real estate investment to an indirect, diversified investment in a portfolio of properties.

13. What are the steps to complete a 721 exchange?

Key steps include selecting a Real Estate Fund that accepts property contributions, negotiating the terms of the property contribution, determining the number of OP Units to be received, and completing the transaction documents. It's crucial to engage with tax advisors and legal professionals throughout this process.

14. How is the value of the contributed property determined in a 721 exchange?

The value is typically determined through an appraisal or negotiation with the Fund, affecting the number of OP Units the property owner will receive. The valuation process is critical and can influence the tax implications of the exchange.

15. Can a 721 exchange be reversed or undone?

Once completed, a 721 exchange generally cannot be reversed, as the property owner has exchanged real estate for securities in a Real Estate Fund. However, OP Units may sometimes be convertible into Fund shares, offering liquidity but also potential tax consequences upon conversion.

16. Are there any restrictions on what can be done with the OP Units received in a 721 exchange?

While OP Units provide the owner with an interest in the Fund's operating partnership, there may be restrictions on their convertibility into Fund shares, including holding periods or market conditions that affect liquidity.

17. What happens to the deferred taxes if the Real Estate Fund shares are eventually sold?

Upon selling the Real Estate Fund shares obtained through OP Unit conversion, the original deferred taxes may become due, in addition to any capital gains taxes on the appreciation of the Real Estate Fund shares themselves.

18. How does a 721 exchange affect estate planning?

OP Units can be beneficial for estate planning, as they can be divided among heirs, potentially offering a step-up in basis upon the owner's death and avoiding capital gains taxes that would have been due on the original property.

19. Can a 721 exchange be used for international properties?

Generally, a 721 exchange involves U.S.-based Real Estate Funds and properties. While some Real Estate Funds may hold international properties, tax deferral benefits under Section 721 are primarily designed for U.S. tax purposes. International property owners should consult with tax professionals for specific advice.

20. Who can facilitate a 721 exchange?

Completing a 721 exchange typically involves a team including a tax advisor, a legal advisor, and the Real Estate Fund's acquisition team. Unlike a 1031 exchange, there's no requirement for a qualified intermediary, but professional guidance is crucial given the complexity of the transaction.

21. How Can Dual City Investments Help?

At Dual City Investments, we help accredited investors build wealth, diversify portfolios, and avoid the hassles of managing property with passive real estate investments. 

Our core acquisition process and multi-pronged value add strategy have produced an average internal rate of return (IRR) of 56% to our investors since inception.

Our Dual City Advantage Fund (DCAF) is a blind pool, private equity, evergreen fund that offers a unique opportunity for accredited investors to participate by contributing cash or contributing their property via a 721 exchange. 

📞 Request a Consultation today to see if a 721 exchange into the Dual City Advantage Fund is the right move for you.