What is a 721 Exchange?

Like a 1031 Exchange, a 721 Exchange is an effective vehicle for deferring capital gains taxes. A 1031 Exchange allows an investor to sell their  investment property and reinvest in another like kind property while Deferring Capital Gains Taxes. Under a 721 Exchange, an investor can sell their property to a partnership in exchange for shares or ownership in that partnership and defer paying capital gains taxes. Below is a summary of the rule;

(a) General Rule-

Section 721 of the Internal Revenue Code states that no gain or loss shall be recognized to a partnership or to any of the partners in the partnership when property is exchanged to the partnership for an interest in the partnership. This means that a partner can exchange property with a partnership in exchange for an ownership interest in the partnership. Under a 721 Exchange, neither the partner nor the partnership must recognize a gain or loss.

(b) The general rule above for a 721 Exchange does not apply to gain realized on the transfer of property to an incorporated partnership that is treated as and investment company (under section 351).

(c) The general rule above may not apply to gain realized on the transfer of property to a partnership if the gain will be included in the gross income of a non-resident alien

721 Exchanges are often used by Real Estate Investment Trusts (REIT’s). These REIT’s own all of their property in a subsidiary partnership that is then controlled by the REIT acting as the general partner. Investors in the REIT can contribute property to the REIT and in return receive ownership shares that are a representative of the economic value of the entire REIT’s portfolio.