Additional flexibility with a Section 721 Exchange

What is a Section 721 Exchange?
Many real estate investment trusts (REITs) utilize Section 721 as a way to acquire property from investors interested in selling their property but who do not want to pay capital gain taxes or find another property as part of a 1031 Exchange. Rather than exchanging property for property or for a Tenant-In-Common (TIC) property interest, IRC Section 721 allows an investor to contribute property directly to a REIT’s operating partnership (the entity through which the REIT acquires and owns its properties) in exchange for operating partnership units (OP Units). This type of transaction is sometimes referred to either as a 721 Exchange or an “UPREIT” transaction.
Contribution of land sale proceeds.
In order for an investor to contribute a property to a REIT through an UPREIT transaction, the property must meet the REIT’s investment criteria, which typically include a requirement for institutional grade property. Few individual investors own this type of property, and therefore are not able to directly contribute a property to a REIT through a 721 Exchange. However, by exchanging a property that does not meet the REIT’s criteria for institutional grade property, an investor may then have the opportunity to contribute the money from property sale proceeds to a REIT in a tax deferred 721 Exchange. The diagram below outlines the process of exchanging land sale proceeds for OP Units of the REIT.

The ownership of OP Units may offer investors the following benefits:

• Access to a diversified portfolio of institutional quality real estate
• Deferral of capital gain taxes
• Realization of the economic benefits of the REIT’s entire portfolio, including capital appreciation and distributions of operating income
• Convertibility of OP Units into REIT shares
• Management of tax gain through partial conversion and liquidation of OP Units over time
• Full divisibility of OP Units
• Upon death, receipt by heirs of a stepped-up basis in OP Units (permanent tax-deferral with no capital gain tax due.)