Investors who appreciate the tax deferral benefits of a 1031 Exchange or a 1031 Tenant in Common Exchange (TIC) should recognize the tax advantages of a 1031-721 Exchange.
Section 721 of the Internal Revenue Code allows an investor to contribute a property to a REIT, an acronym for Real Estate Investment Trust in exchange for operating partnership units of the REIT itself. This transaction is called a 721 Exchange, also known as an UPREIT, an Umbrella Partnership Real Estate Investment Trust.
Some real estate sponsor firms have combined the likes of a 1031 exchange – Tenant In Common (TIC) with a 721 Exchange – UPREIT. For example, an investor can sell his investment or business property, termed the Relinquished Property, and following the 1031 Exchange rules acquire another ‘like kind’ property of similar or greater value. This Replacement Property is used as a rental or business investment property for approximately 12 to 24 months, demonstrating the investor’s intent to hold it, thus qualifying for 1031 capital gains tax deferral. Then the investor can ‘contribute’ the Replacement Property to a REIT in exchange for the REITs Operating Partnership units (OP units).
Because the investor does NOT receive cash, in the eyes of the Internal Revenue Service, this transaction is not a sale and does not trigger capital gains taxes. However, additional steps must be taken to ensure that the transaction in which the investor contributes his 1031 Replacement Property is not disqualified by the IRS. According to 1031 Exchange rules, a Replacement Property must be held for business use by the investor to defer capital gains taxes and not for eventual resale to the REIT.
It is a corporation or business company which holds a diversified portfolio of income producing assets such as shopping centers, office buildings, hotels, etc. It has combined the capital of hundreds or more shareholders to acquire these real estate investment properties.
To qualify as a REIT and gain the advantages of a pass-through entity, the organization must comply with several Internal Revenue Code Provisions regarding assets earned:
- A REIT must pay out at least 90% of its income to stockholders.
- At least 75% of its gross income must be from rents or earned mortgage interest.
To potentially avoid disqualification of the tax exchange benefits, when the investor’s Replacement Property is “contributed to the REIT”, a creative solution has been developed which works like this:
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Grant ConnessGrant has written 6 articles for us.
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Joshua Dorkin
Charles Feldman
Ted Karsch.
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Great Post.
One disturbing trend that people should also be aware of in 1031 exchanges is abuse and mismanagement of money by exchange companies. I encourage everyone to thoroughly vet any potential qualified intermediary.
Consider working with a 1031 exchange company that deposits your money only in money-market accounts that invest in government backed securities. With uncertain market conditions, it’s the only way to ensure your money will be there when you need it.
Is it possible to sell a property, and purchse operating partnership units in a REIT to complete the 1031 transaction ? Does anyone have any thoughts or advise ?