1031 vs 721 Exchange: A Guide to Tax and Investment Options

Both 1031 and 721 exchanges offer tax benefits for real estate investors, but they serve different purposes. A 1031 exchange allows investors to defer capital gains taxes when selling a property and buying a new one of equal or greater value.

A 1031 exchange is also known as a like-kind exchange, which means the property being sold must be of the same type as the one being bought. This can include residential or commercial properties, as long as they are held for investment or used in a trade or business.

To qualify for a 1031 exchange, the property being sold must be held for at least a year, and the proceeds must be used to buy a new property within 180 days.

An exchange in the context of 1031 and 721 exchanges is a process that allows property owners to trade one property for another, deferring capital gains tax. This process is governed by the IRC Section 1031 and involves a qualified intermediary to facilitate the exchange.

To qualify for a 1031 exchange, the sold property must be traded for another property of equal or greater value, and the exchange must go through a qualified intermediary. The purchase and sale of properties must occur within a specific time frame: 45 days for finding the replacement property and 180 days for purchasing the property.

A 1031 exchange is one of the most popular tax strategies available for property owners who want to defer capital gains tax. In a 1031 exchange, the property owner transfers a relinquished property and receives a replacement property without receiving any of the funds from the sale of the relinquished property.

Investors must notify the IRS when completing a 721 exchange, and knowing the risks of a 721 exchange can help you avoid unwanted penalties and tax payments. The exchange itself doesn't mean tax-free; instead, it's a tax deferment, and eventually, investors must pay taxes after selling their replacement property unless they pass away.

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Both 1031 and 721 exchanges share some similarities that make them attractive to real estate investors.

Similarities include that the property being sold must be held for business or investment use, and both defer capital gain tax, depreciation recapture, state and net investment income tax when properly executed.

Both exchanges also allow for investment diversification, giving investors the opportunity to exit existing real estate investments and reinvest without tax consequences.

A key benefit of both exchanges is that heirs of the taxpayer can receive a "step-up" in basis if they pass away still vested with the REIT interest or certain items of real and/or personal property qualifying as "replacement property".

Here are the key similarities between 1031 and 721 exchanges:

Both 1031 and 721 exchanges share some key similarities that make them attractive to real estate investors.

The property being sold must be held for business or investment use to qualify for these exchanges.

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One of the main benefits of both 1031 and 721 exchanges is that they can help defer capital gain tax.

Depreciation recapture and state and net investment income tax can also be deferred when these exchanges are properly executed.

Both exchanges allow for investment diversification, giving investors the opportunity to reinvest in new properties.

Investors can also take advantage of a "step-up" in basis if they pass away still vested with the REIT interest or certain items of real and/or personal property qualifying as "replacement property".

Here are the key similarities between 1031 and 721 exchanges:

The differences between a 1031 exchange and a 721 exchange are significant. A Qualified Intermediary facilitates a 1031 exchange, while a 721 exchange is facilitated by the REIT sponsor.

A key difference is the timeline for a 721 exchange, which does not have the same 45-day Identification and 180-day Exchange period as a 1031 exchange. This means that investors have more flexibility with a 721 exchange.

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In a 721 exchange, a REIT must be willing to acquire the relinquished property, or the investor can go through the process described above with a 1031 exchange and later trade for the REIT shares. This can be a more straightforward process.

However, in a 721 exchange, once an investor sells the property to the REIT, they cannot do another exchange upon sale of the shares held. This is a major limitation of a 721 exchange.

Here are some key differences between a 1031 exchange and a 721 exchange:

With a 721 exchange, investors give up control over the property and must rely on the REIT to manage it. This can be a relief for investors who don't want to deal with maintenance and property management burdens.

To qualify for a 1031 exchange, the property must be held for productive use in a trade or business or investment. This means it can be a vacant lot, an apartment building, or a single-family residence.

Properties held for personal use do not qualify, including primary or secondary homes. A 1031 exchange is exclusive to business, investment, or trading properties.

The sold property must exchange for another property of equal or greater value. This is a requirement for both 1031 and 721 exchanges. The purchase and sale of properties must occur within a specific time frame: 45 days for finding the replacement property and 180 days for purchasing the property.

Investors must notify the IRS when completing a 721 exchange. This is an important step to avoid unwanted penalties and tax payments. Knowing the qualifications and requirements can help you navigate the process successfully.

You've got two main exchange options to consider: 1031 and 721 exchanges. Both can help you defer taxes, but they lead to different real estate investing paths.

A 1031 exchange allows you to trade one investment property for another, deferring capital gains tax. You can use this strategy repeatedly, accumulating wealth faster. It's an effective tool for building generational wealth.

With a 721 exchange, you can purchase REIT shares and manage risks through diversification. This option allows for passive income opportunities, paying dividends to shareholders instead of relying on cash flow from individual properties.

A 721 exchange is a type of exchange that allows you to swap one property for another of equal or greater value.

You must go through a qualified intermediary to make a 721 exchange happen.

The purchase and sale of properties in a 721 exchange must occur within 45 days for finding the replacement property and 180 days for purchasing it.

You'll need to notify the IRS when completing a 721 exchange.

If the property you're swapping isn't of equal or greater value, you might have to pay capital gains taxes on the difference.

You have two main options to consider: 1031 and 721 exchanges. Neither is necessarily better than the other, you just need to know which path you'd like to take.

Both 1031 and 721 exchanges can help with tax deferrals, but they lead to different real estate investing paths. You can use a 1031 exchange and a 721 exchange together to get the final investment you want.

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Flock Homes specializes in 721 exchanges and 1031 DST exchanges, and they can help you decide which option is right for you. Call them at (720) 703-9992 for assistance.

A 721 exchange allows for passive income opportunities, paying dividends to shareholders instead of relying on cash flow from properties. This can result in a more stable income stream.

With a 1031 exchange, you can defer capital gains tax, accumulating wealth faster and allowing you to reinvest in various properties as your wealth increases.

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A 1031 exchange is a popular tax strategy that allows property owners 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.

One of the biggest benefits of a 1031 exchange is that it allows you to defer taxes, taking the full return on your investment into another deal. This enables you to repeatedly invest in various investments as wealth increases.

Consider reading: What Advantage Does the 1031 Tax Deferred Exchange Offer

A 721 exchange, on the other hand, allows investors to purchase REIT shares, providing passive income opportunities and diversification. Investors can manage risks through diversification, mainly if a REIT contains properties in different locations.

However, a significant downside to 1031 exchanges is their complexity. Finding the right like-kind property can become time-consuming, especially since investors are on a specific time limit.

Another disadvantage of 721 exchanges is that investors can't perform another deferred tax exchange after receiving REIT shares. REIT shares themselves don't allow for other tax-deferred exchanges compared to 1031 exchanges.

In contrast, a 1031 exchange allows you to continue investing until your passing and leave your properties to your heirs, who won't have to pay accumulated capital gains taxes on 1031 exchange properties.

But, if you're not careful, you can get stuck with REIT shares that you can't easily sell, forcing you to pay capital gains taxes. This is a risk that investors should carefully consider before opting for a 721 exchange.

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Using 1031 and 721 exchanges in tandem can significantly enhance an investor's long-term strategy, particularly when considering the lifecycle of their investment journey. This approach can provide a sustainable income stream in retirement, with dividends from REITs offering a steady income stream.

By transitioning to a 721 exchange, investors can move to a more passive income stream, which is less demanding in management and offers more liquidity. This can be particularly appealing for retirees who want to reduce their active management roles.

A strategic blend of 1031 and 721 exchanges can also simplify the inheritance process, making it easier for heirs to manage the investment. This is because transferring shares of a REIT is typically less complex than transferring real estate holdings.

Here are some key benefits of using 1031 and 721 exchanges in estate planning:

Estate planning is a crucial aspect of long-term planning, and it's essential to consider how your investments will be passed down to your heirs. Minimizing tax burden for heirs can be achieved through the use of 721 exchanges, which offer a step-up in basis advantage.

This means that heirs may receive the investment at its current market value, not the original investor's purchase value. A step-up in basis can significantly reduce or eliminate capital gains taxes for heirs.

Transferring shares of a REIT is typically less complex than transferring real estate holdings, making it a more straightforward process for heirs. This simplicity can be a relief for those who may not be familiar with or interested in managing real estate.

The liquidity of REIT shares offers heirs more options, including the ability to retain the shares and receive dividend income or sell them and invest elsewhere according to their financial goals and needs.

Here are the key benefits of using 721 exchanges for estate planning:

Long-term planning is crucial for a smooth investment journey. By utilizing 1031 and 721 exchanges, investors can create a phased approach to their investment lifecycle.

Initially, investors might start with a 1031 exchange to grow their real estate portfolio and defer taxes. This phase is typically characterized by active management and reinvestment in various properties to maximize growth and leverage market trends.

As investors approach retirement or wish to reduce their active management roles, transitioning to a 721 exchange becomes advantageous. By converting their real estate holdings into REIT shares, investors move to a more passive income stream.

A 721 exchange is particularly appealing for retirees, as it ensures a steady income through dividends from REITs. This income stream is less demanding in management and offers more liquidity.

The diversification within REITs also spreads risk across various properties and geographical locations, providing a more stable investment in the face of market fluctuations.

Here's a summary of the benefits of a phased approach to investment lifecycle: