One of Real Estate's Best Kept Secrets

[Julio Gonzalez]

If you are wanting to sell your real estate property, but are worried about paying taxes on the capital gains, a great strategy to consider is a 721 Exchange. Section 721 of the Internal Revenue code allows an investor to exchange property held for investment or business purposes for shares in a Real Estate Investment Trust (REIT) or an Operating Partnership without triggering a taxable event.

Many investors are aware of a 1031 Exchange where an investor must find a replacement property to defer capital gains taxes on the property that was sold. Section 721 differs in that it allows investors to sell their real estate property without finding a replacement property. This type of exchange provides investors with a way of increasing liquidity and diversification of their real estate investments, while deferring very costly capital gains and depreciation recapture taxes that may result from the sale of properties. A 721 Exchange is a great investment tool for real estate investors that are looking for diversification, tax-deferral or estate planning.

Investors can contribute the funds from a property that has already been sold into a 721 Operating Company and receive Operating Partnership Units (OPU) or they can also sell the property directly to the Operating Company in exchange for OPUs.

There are many benefits associated with a 721 Exchange. Here are a few below.

• Consistent Income: Operating Partnerships can issue dividends or distributions so that the investor has cash flow.
• Tax Deferral: Deferring the taxable income from the sale of their real estate property.
• Portfolio Diversification: Enables the investor to achieve diversification across geography, industry, tenant and asset class in an Operating Partnership structure. The investor is no longer dependent on just one asset to provide cash flow and appreciation.
• Passive: Allows investors to trade an actively managed real estate asset for a passive investment in an Operating Company that is typically run by an institutional asset management firm.
• Estate Planning: This is a great estate planning tool to utilize when preparing an investors real estate asset to be passed down to their heirs. Instead of real estate assets, their heirs can receive easily divisible shares in the Operating Partnership that can be much more easily liquidated upon passing of the estate. The heirs can choose to hold their shares and receive dividends or sell them.

Have you used a 721 Exchange before? If so, what advice do you have for other real estate investors?