Real estate investors seeking to diversify beyond a single property without facing an immediate tax bill are adopting 721 exchanges. This method lets owners trade direct property ownership for ownership units in a partnership or fund.
Kurt Houtkooper, CEO of Hamilton Zanze, stated the approach has become more common over the past two years as private real estate investment trusts and wealth managers influence property decisions. “It’s become very popular in the last 12 to 24 months,” he noted.
How a 721 exchange differs from a 1031
Most commercial real estate investors recognize the 1031 exchange: sell a property, reinvest the proceeds in another, and defer capital gains tax. A 721 exchange follows a different process. The owner contributes the asset to a partnership or fund in exchange for ownership units rather than purchasing a replacement property.
A 721 exchange does not require following the strict timing rules of a 1031, such as identifying replacement property within 45 days and completing the acquisition within 180 days. The investor no longer holds direct title but gains an interest in the partnership that now owns the property. The tax is deferred, not eliminated. The investor’s tax basis generally carries into the partnership interest, and taxes can become due if the interest is later sold or the transaction otherwise runs afoul of applicable tax rules. As with any exchange structure, the tax result depends on the details of the transaction and should be reviewed with legal and tax advisers.
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The structure isn’t new. It emerged under the UPREIT model in the 1990s when owners contributed properties to public REITs in exchange for operating partnership units. The appeal was simple: defer taxes while converting a single asset into a stake in a larger real estate platform. The tradeoff involved surrendering direct control.
Private REITs, real estate funds, and continuation vehicles are now bringing the model back. Houtkooper explained that the growth of private vehicles has made 721 exchanges more appealing by offering more options for contributed properties beyond the public REIT market.
Reasons some owners choose the partnership route
A 721 exchange can attract owners with long-held, low-basis properties who wish to remain in real estate but avoid managing another building. Diversification is another advantage. Instead of relying on one asset in one market, the investor gains exposure to a portfolio of properties. For those whose wealth is tied to a single multifamily building, this can reduce risk—though it introduces new risks tied to the fund’s strategy and sponsor.
Key considerations for investors
The contributed property is only one part of the decision. Investors must also evaluate the partnership or fund receiving it. Important factors include the sponsor’s experience, investment strategy, portfolio mix, leverage, fees, governance rights, and redemption policies.
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Control matters significantly. A direct owner decides when to refinance, renovate, or sell. A 721 contributor becomes a passive unit holder, leaving those decisions to the fund manager. This can be beneficial for owners ready to step back but means relinquishing control.
Liquidity is another issue. Some vehicles offer redemption rights or transfer options, but these vary and may include restrictions. Partnership units aren’t as liquid as publicly traded stocks, and investors shouldn’t expect easy cash-outs.
The rising interest in 721 exchanges mirrors a broader trend in multifamily real estate. More owners want to move away from concentrated, hands-on ownership while keeping tax deferral and real estate exposure. Whether a 721 exchange works depends on the quality and terms of the partnership involved.
For those looking to sell a property quickly, alternative methods like selling as-is may also be worth considering.
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