The 721 exchange, also known as a contribution or an Umbrella Real Estate Investment Trust (UPREIT) exchange, is a tax-deferred transaction that allows investors to exchange their ownership in a property for ownership in a larger, more diversified real estate investment without incurring immediate taxes on the gains from the sale of the original property.
The 721 exchange was created in 1954 because of a private letter ruling by the Internal Revenue Service (IRS) in response to a request from a real estate investment trust (REIT) seeking to acquire a large portfolio of real estate assets without incurring immediate tax liabilities.
Prior to the creation of the 721 exchange, investors who wanted to exchange ownership in a property for ownership in a REIT had to sell their property, pay capital gains taxes on any profits, and then use the proceeds to purchase shares in the REIT. This process could be costly and time-consuming, and it discouraged many investors from taking advantage of the benefits of investing in a REIT.
With the introduction of the 721 exchange, investors could contribute their ownership in a property directly to a REIT in exchange for operating partnership units (OP units) in the REIT. They could convert these OP units into shares of the REIT over time, giving investors a tax-efficient way to diversify their real estate holdings and benefit from the income and growth potential of a professionally managed portfolio of properties.
Since the 721 was created, it has become an increasingly popular strategy for real estate investors who want to defer taxes on the sale of their properties and gain access to a wider range of real estate assets. Here's an example of how a real estate investor might use a 721 exchange:
You own a commercial property worth $10 million that has appreciated significantly since you bought it. Now let’s say you want to sell the property and reinvest the proceeds into other real estate assets, but you don't want to pay capital gains taxes on the sale.
Instead, you decide to do a 721 exchange. You contribute your property into a REIT partnership, which issues you shares of the REIT in exchange for your property. You now own equity in the REIT, which owns the commercial property.
By doing a 721 exchange, you can potentially defer paying taxes on the sale of your property, while still accessing the liquidity and diversification benefits of a REIT. Additionally, if the REIT performs well, you might earn a return on your investment through dividends and share price appreciation.
The 721 exchange, UPREIT, was created as a tax-efficient way for real estate investors to diversify their holdings and gain exposure to a professionally managed portfolio of properties. Since its inception, the 721 exchange has become an increasingly popular strategy for deferring taxes on the sale of real estate assets and gaining access to a wider range of investment opportunities. As the real estate market continues to evolve, it is likely that the 721 exchange will continue to play an important role in helping investors achieve their financial goals.