Investor Resources

Today we're going to compare the 721 exchange to the 1031 exchange. Before I get into comparisons as well as the pros and cons of each, I have to explain what a 721 is. The 721 exchange is when you take a real property and contribute it to a partnership. That partnership could be a REIT, could be an LLC, could be a single asset, or could be multiple assets. In exchange for the equity in that property, the owner receives units or op-units.

During that exchange, capital gains are deferred; It's not a taxable event until they exit this entity. In contrast, a 1031 exchange is when you take a real property, you sell that real property, and the proceeds are held with a qualified intermediary. Those proceeds are then used to buy a replacement property, replacing the debt and equity, and during that exchange, the capital gains are also deferred. 

Now, the difference between the two has to do with the entity of the 721 more so than the mechanics of the exchange. The entity that the 721 exchange is going into will dictate if there's liquidity, any lockup period, cash flow, how diversified it is, and so forth. In the 1031 exchange, the owner oversees the whole process, and they end up with a property that they're still going to have to manage, and it's not exactly passive. In most cases, the 721 is completely passive, and there could be extra added benefits depending on what entity you enter.

In either case, taxes are deferred, they are not forgiven nor forgotten. When you eventually go to cash, you'll have to pay the tax man, or as in today's tax law, if you leave the 1031 asset to your heirs, they'll inherit it up a stepped-up basis. The same thing goes with the units in a 721. If you leave those to your heirs, they'll inherit that at a stepped-up basis as well. 

So, I hope this quick explanation clarifies the differences and the pros and cons of the 721 versus the 1031 exchange.