What is the difference between a 1031 Exchange and a 721 Exchange?

Both a 1031 exchange and a 721 exchange allow (“Exchangor” or “Taxpayer”) Person intending to conduct a 1031 tax deferred exchange, who transfers a relinquished property and thereafter receives a replacement property. Exchanger s to defer capital gains and other taxes on the sale of business or investment use real estate when proper procedures are followed, however they do have differences and they cannot be used interchangeably as each has specific considerations.

What is a 1031 exchange?

1031 exchange is one of the most popular tax strategies available when selling and buying real estate “held for productive use in a trade or business or investment”. Property owners of real estate used for business or investment use can utilize a 1031 exchange on the sale of the property to defer capital gains, depreciation recapture, state, and net investment income tax when they reinvest the proceeds from the sale into the purchase of qualifying property. It does not have to be the same kind of property. All types of real estate are considered like kind to all other types.

In a 1031 exchange, the (“Exchangor” or “Taxpayer”) Person intending to conduct a 1031 tax deferred exchange, who transfers a relinquished property and thereafter receives a replacement property. Exchanger is not permitted to receive nor control and is not allowed to “benefit” from the funds from the sale of their sold property, the relinquished property. An example of benefitting would be to pledge the account as collateral for a loan. The funds are held with a Qualified Intermediary until the time the (“Exchangor” or “Taxpayer”) Person intending to conduct a 1031 tax deferred exchange, who transfers a relinquished property and thereafter receives a replacement property. Exchanger is ready to close on the sale of their new property, the Replacement Property. The funds are then directly used to purchase the replacement property. Because the (“Exchangor” or “Taxpayer”) Person intending to conduct a 1031 tax deferred exchange, who transfers a relinquished property and thereafter receives a replacement property. Exchanger never actually had any access or benefit from the funds and since the (“Exchangor” or “Taxpayer”) Person intending to conduct a 1031 tax deferred exchange, who transfers a relinquished property and thereafter receives a replacement property. Exchanger traded the relinquished property for the replacement property through the Qualified Intermediary, they may defer the taxes they would normally pay if they had sold the property outright and retained the money.

What is a 721 exchange?

A 721 exchange, formally referred to as a 721 Umbrella Partnership Real Estate Investment (UpREIT), is similar to a 1031 exchange in that a real estate investor can sell a property used for business or investment use and defer taxes on the sale if they reinvest the funds by following specific criteria.

In a 721 exchange, the investor either (1) transfers ownership of the relinquished property to the REIT and receives an equivalent value in the form of operating partnership units or (2) or sells to a third party of choice using a 1031 exchange and investing the funds into a DST, often made available by the REIT. When sufficient time passes, usually two years, the DST interest can be traded for A trust that invests primarily in real estate, and passes the income, losses, and other tax items to its investors. Investments in REITs are classified as securities, and as such do not qualify for Section 1031 exchange treatment. Real Estate Investment Trust (REIT) shares.

Similarities and Differences of a 1031 Exchange and 721 Exchange

Similarities

There are a handful of similarities between a 1031 exchange and a 721 exchange, which include:

• Property being sold must be held for business or investment use
   
• When properly executed, both defer capital gain tax, depreciation recapture, state and net investment income tax
   
• Both allow for investment diversification
   
• Both allow heirs of the Taxpayer to get a “step-up” in basis if they pass away still vested with the REIT interest or Those certain items of real and/or personal property qualifying as “replacement property” within the meaning of Treasury Regulations Section 1.1031(k)‑1(a) and either: (a) received by the taxpayer within the designation period in accordance with Treasury Regulations Section 1.1031(k)‑1(c)(1) or (b) identified in a written designation notice signed by the taxpayer and hand delivered, mailed, telecopied or otherwise sent to the qualified intermediary before the end of the designation period in accordance with Treasury Regulations Sections 1.1031(k)‑1(b) and (c). The definition of “replacement property” shall not include property the identification of which has been revoked by the taxpayer in accordance with Treasury Regulations Section 1.1031(k)‑1(c)(6); (“New Asset”) Property or properties properly received by a taxpayer as part of a 1031 exchange. Replacement Property interest in the case of a 1031 exchange

Differences

The differences between a 1031 exchange and a 721 exchange are notable and include:

• A Qualified Intermediary facilitates a Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange , while a 721 exchange is facilitated by the REIT sponsor
   
• 721 exchanges do not have the same timelines, 45-day Identification and 180-day Exchange period, as a Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange 1031 exchange Replacement Property Identification Rules do not apply to 721 exchanges
   
• In a 721 exchange a REIT must be willing to either acquire your Those certain items of real and/or personal property described in the relinquished property contract and qualifying as “relinquished property” within the meaning of Treasury Regulations Section 1.1031(k)-1(a); The "Old Asset”, property or properties given up or conveyed by a taxpayer as part of a 1031 exchange. Relinquished Property , or go through the process described above with a 1031 exchange and later trade for the REIT shares.
   
• In a 721 exchange, once an investor sells the property to the REIT, they cannot do another exchange upon sale of the shares held. Once the REIT shares are sold, all the deferred taxes become payable regardless of entering into a new REIT investment. However, under 1031 exchange a (“Exchangor" or "Exchanger") Individual or entity desiring an exchange. Taxpayer can do consecutive exchanges indefinitely to continue deferral.

Both 1031 and 721 exchanges provide real estate investors the opportunity exit out of existing real estate investment and reinvest without tax consequences. However, based on the details above they are unique and advanced planning and a thorough understanding should be in place prior to embarking on either. It is always recommended to talk with your CPA, Tax Advisor, or Financial Advisor prior to implementing any tax deferral strategies.

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified  A person acting to facilitate an exchange under section 1031 and the regulations. This person may not be the taxpayer or a disqualified person. Section 1.1031(k)-1(g)(4)(iii) requires that, for an intermediary to be a qualified intermediary, the intermediary must enter into a written "exchange" agreement with the taxpayer and, as required by the exchange agreement, acquire the relinquished property from the taxpayer, transfer the relinquished property, acquire the replacement property, and transfer the replacement property to the taxpayer. Intermediary , and as such does not offer or sell investments or provide investment, legal, or tax advice.