Definition
A 721 exchange lets a property owner contribute real estate to a real estate investment trust's operating partnership in exchange for partnership units, deferring capital gains tax.
How It Works
Under Section 721, contributing property for operating partnership units is not a taxable event. The owner trades direct property ownership for units in a diversified REIT structure, often after a 1031 into a property the REIT wants, gaining diversification and passive income while deferring tax.
Example
An investor contributes an apartment building into a REIT's operating partnership through a 721 exchange, receiving units that provide diversified, passive exposure without triggering tax on the built-in gain.
When It Works Best
It works best for owners wanting to exit active management and gain diversification while continuing to defer gain, often as a later step after a 1031.
Who It Applies To
Real estate owners with appreciated property seeking passive, diversified exposure.
Watch-Outs
Converting units to REIT shares later is generally taxable, the move is effectively one-directional out of 1031 eligibility, and the investor depends on the REIT's management and performance.
