An Essential Tax Planning Strategy
Learn about this sophisticated and powerful strategy that offers investors the opportunity to maximize real estate investment portfolios.
Potential Benefits of a 721 Exchange
The 721 exchange is a sophisticated investment structure that is attractive for many investors for the following reasons:
Access to an existing and growing portfolio of professionally managed, institutional-quality real estate diversified by asset classes and geography.
Operating partnership aims to generate consistent income through actively managed, income-producing properties. Distributions and investment outcomes are not guaranteed. Capital appreciation may occur if property values within portfolio increases.
Planning
Heirs of limited partners may receive a step-up in tax basis, potentially eliminating previously deferred capital gains taxes. Heirs may choose individually what to do upon the sale of inherited interests —unlike traditional heirs who often must decide together.
Self-Directed Liquidity
A redemption program for limited partnership interests may provide more liquidity, allowing property owners to redeem interests in whole or in part, potentially managing periodic taxable gain recognition in alignment with specific financial goals and objectives.
Understanding UPREITs
The UPREIT (Umbrella Partnership Real Estate Investment Trust) allows property owners to contribute real estate for limited partnership units (OP units) through a 721 exchange. These units can later be converted into REIT shares or cash, offering potential liquidity benefits.*
The UPREIT structure consists of two main components: (1) the REIT, and (2) its operating partnership which holds and, typically, manages the actual real estate assets within the REIT.
*Pursuant to the terms of the limited partnership agreement.
The 721 Exchange
Via DST
Most investors will encounter a 721 exchange/UPREIT transaction via a combination 1031/721 exchange utilizing a Delaware statutory trust (DST) as a conduit.
To complete this type of combination exchange, an investor will first invest in a DST that is designated for a 1031/721 program. 721 DSTs typically have a shorter hold period than traditional 1031 DSTs, averaging two to three years. At the end of the hold period, the REIT's operating partnership may exercise its option to acquire the properties owned by the DST and the investors will receive partnership units in the operating partnership of the REIT (OP units).
1031 v. 721 Exchange Breakdown
The chart below compares a traditional 1031 DST investment, in which the DST investors will have the ability to complete future 1031 exchanges at the time of exit, with a 721 DST investment, in which the investors will participate in a 721 exchange into the operating partnership of a REIT at the time of exit, if that operating partnership elects to exercise its option to acquire the DST’s assets.
How a 721 Exchange Strategy Can Support Different Investor Goals
This animated case study illustrates how a 721 exchange may help support long-term investor objectives. Explore how a 721 exchange into an UPREIT strategy can preserve tax deferral, reduce direct ownership responsibilities, increase portfolio diversification, and address legacy planning needs.
