When it comes to tax-deferral strategies when selling real estate, most everyone has heard of the 1031 exchange. But, that’s not the only option. In fact, there are several options.

You likely have never heard of a 721 exchange, and that might be a viable option for some. I’m going to explain to you all the in’s and out’s of a 721 exchange, the benefits and drawbacks, and some examples of how they work.

A 721 exchange of real estate is a type of transaction that allows property owners to exchange their real estate assets while deferring taxes. This type of exchange also allows investors to diversify their real estate holdings, which can help mitigate risk. By pooling their assets with other investors, individuals can gain access to a broader range of property types, locations, and investment strategies. This can help to reduce the impact of market volatility on a single property or asset and help investors achieve more stable returns over time. 

One of the primary benefits of a 721 exchange is that it allows investors to defer paying capital gains taxes on the sale of their property. In other words, by rolling over the proceeds from the sale of one property into another property or a portfolio of properties, the investor can take advantage of tax deferral laws and preserve more of their capital for future investments. 

However, there are also some drawbacks to 721 exchanges. One major concern is that the transaction is complex. Investors must navigate a variety of legal and regulatory requirements to complete a 721 exchange. Additionally, the tax deferral benefits that come with a 721 exchange are not permanent and must eventually be paid back. In other words, the taxes owed will simply be deferred until a later date. 

Specifically, the investor will owe taxes on the difference between the sale price of their interest in the portfolio and their original cost basis, which includes the deferred taxes from the sale of the original property.

Despite these challenges, many investors find that a 721 exchange can be a valuable tool for building a diversified real estate portfolio. To perform a 721 exchange, investors typically work with a professional investment firm that specializes in this type of transaction. 

For example, let’s consider a situation where an investor owns a commercial property that they would like to sell. To avoid paying taxes on the proceeds of the sale, the investor could partner with other investors through a 721 exchange. The investor would contribute their commercial property to the exchange and receive an interest in a diversified portfolio of real estate assets instead. 

By diversifying their holdings through a 721 exchange, the investor could potentially reduce their overall risk and achieve more stable returns over time. However, they would still need to pay taxes on the sale of their original property eventually, so this strategy should be approached with careful consideration and expert guidance. 

Overall, a 721 exchange can be a powerful tool for deferring taxes and building a diversified real estate portfolio. However, investors should be aware of the complexities involved and seek professional guidance to ensure the best possible outcome for their investment strategies.

All tax-deferral strategies are going have some benefits and drawbacks, so it’s important to do your research and weigh all aspects before coming to a decision.

If you have any questions, reach out below!