BuyersSellers February 1, 2024

1031 Exchange vs 721 Exchange

The 721 exchange and the 1031 exchange are both tax-deferred strategies, but they apply to different types of real estate transactions and structures. Here are the key differences between the two:

1031 Exchange: This provision, also known as a like-kind exchange under Section 1031 of the Internal Revenue Code, applies to the exchange of like-kind properties. It is commonly used for direct real estate investments, allowing an investor to defer capital gains taxes by reinvesting the proceeds into a similar property.

721 Exchange: A 721 exchange, on the other hand, is specifically designed for real estate investment trusts (REITs). It allows investors to exchange real estate assets for shares in a REIT without triggering immediate tax liabilities.

Application in Investment Structures

1031 Exchange: Directly benefits individual real estate investors or entities holding real property. The primary focus is on deferring capital gains taxes for those actively involved in real estate ownership.

721 Exchange: Geared toward investors in REITs, which are typically structured as corporations or trusts that own and operate income-producing real estate. Investors looking to exit direct real estate ownership while maintaining exposure to the real estate market may find the 721-exchange beneficial.

Flexibility and Diversification

1031 Exchange: Provides flexibility for investors to defer taxes while upgrading or diversifying their real estate portfolios. It allows investors to transition between different types of real estate assets, such as residential to commercial or vice versa.

721 Exchange: Offers flexibility in transitioning from direct property ownership to a more diversified portfolio within a REIT structure. This can be particularly appealing for investors seeking exposure to a broad range of real estate assets without managing properties directly.

Estate Planning Considerations

1031 Exchange: While it allows for the deferral of capital gains taxes, the tax liability may eventually be triggered upon the sale of the final property or through other means. Estate planning strategies may still be necessary.

721 Exchange: Provides potential estate planning benefits, especially for those looking to pass down assets to heirs. Structuring investments within a REIT allows for a streamlined and potentially tax-efficient transfer of assets.

The 1031 exchange is a versatile tool for deferring capital gains taxes in direct real estate transactions, while the 721 exchange caters specifically to those invested in real estate through the vehicle of REITs. The choice between the two depends on the investor’s goals, the nature of their real estate holdings, and their desired level of involvement in property management. Consulting with tax professionals or financial advisors is crucial when considering either exchange to ensure compliance with tax regulations and optimal financial planning.