The 721 Exchange, also known as an UPREIT (Umbrella Partnership Real Estate Investment Trust), is gaining prominence in the real estate investment landscape. This tax-deferred transaction, governed by Section 721 of the U.S. Internal Revenue Code, allows investors to exchange their ownership in a single asset for units in an operating partnership, providing a means to defer both federal and state taxes.

The 721 Exchange differs from the well-established 1031 Exchange in several key ways, particularly in its tax deferral benefits and the structure of the investment. The rise of the 721 Exchange can be attributed to factors such as tax deferral, increased flexibility and diversity, legal protection, and the availability of educational resources.

HOW THE 721 EXCHANGE WORKS

In a 721 Exchange, investors contribute their property to the operating partnership (OP) of an UPREIT in exchange for shares in that operating partnership, or OP Units. Subsequently, the investor becomes a unit holder and benefits from the passive income generated by the UPREIT, as well as the potential for appreciation of the real estate, depreciation tax shelter and income in the form of dividends.

ADVANTAGES AND DISADVANTAGES

The 721 Exchange offers advantages such as passive income, investment diversity and estate planning benefits. However, there are also disadvantages, including restrictions on direct property contribution, potential tax implications upon subsequent conversion of OP Units and limitations on subsequent exchanges.

In conclusion, the 721 Exchange is expected to become an increasingly popular option for investors due to its ability to defer both federal and state taxes, combined with the flexibility, legal protection and risk diversification it offers. As more investors become aware of its benefits, it is expected to play a more significant role in the real estate investment landscape.

Greg Laskody (greg@HAUTEcre.com) is principal of both HAUTE Commercial Real Estate and MasterCRE.