721 exchanges are becoming a more frequent topic of discussion at multifamily and commercial real estate conferences, where owners are weighing ways to move beyond a single-property investment without triggering an immediate tax bill. Kurt Houtkooper, CEO of Hamilton Zanze, has been part of those conversations with industry audiences as the structure gains traction amid the proliferation of private REITs, the growing role of private capital in institutional real estate and greater involvement from RIAs and wealth managers in clients’ property decisions.
“It’s become very popular over the last 12 to 24 months,” Houtkooper tells GlobeSt.com.
Most commercial real estate investors know the basic logic of a 1031 exchange: Sell a property, reinvest the proceeds in replacement real estate and defer the capital gains tax. A 721 exchange takes a different route. Rather than sell a building and acquire another one, the owner contributes the property to a partnership or fund in return for ownership units in that vehicle.
That difference can make 721 exchanges relevant to owners who have built substantial equity in a property but no longer want the concentration, management obligations or succession issues that come with direct ownership. It can also provide another option for investors who want to remain in real estate while shifting their ownership from one asset to a broader portfolio.
How The Structure Works
A 721 exchange is named for Section 721 of the Internal Revenue Code, which generally allows property to be contributed to a partnership in exchange for an interest in that partnership without recognizing gain at the time of contribution. In a real estate transaction, the property owner contributes a building or potentially a portfolio to a partnership, fund or other qualifying vehicles.
In exchange, the owner receives partnership units or fund shares based on the agreed value of the contributed asset. The partnership now owns the real estate, while the former owner holds an interest in the partnership rather than direct title to the property.
That is a fundamental distinction from a 1031 exchange. With a 1031, the investor stays directly invested in replacement real estate and must follow strict timing rules, including identifying replacement property within 45 days and completing the acquisition within 180 days. In a 721 transaction, the investor is exchanging property for an ownership interest in a real estate vehicle.
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.
The Return Of The UPREIT Model
Many investors have encountered the 721 structure before under another name: the UPREIT. The model became popular in the 1990s as owners contributed real estate to the operating partnerships of public REITs in exchange for operating partnership units.
For a property owner, the appeal was clear. The owner could defer taxes associated with a sale while converting a position in one building into units tied to a larger real estate platform. The tradeoff was that the owner gave up direct control over the specific asset and accepted the risks and opportunities of the larger REIT or partnership.
The same basic format is now re-emerging through private REITs, real estate funds and continuation vehicles. Houtkooper said the expansion of private vehicles has brought the 721 structure back into focus because it gives owners more potential destinations for contributed properties than the public REIT market alone.
The resurgence also coincides with a broader change in how wealthy real estate owners approach portfolio management. In the past, an investor who owned an apartment building might sell it through a broker and independently execute a 1031 exchange. Today, Houtkooper said, more RIAs and wealth managers are becoming involved in the process, helping clients consider their real estate alongside their broader investment, liquidity and estate-planning objectives.
Why Owners Are Considering It
A 721 exchange can appeal to an owner with a long-held, low-basis property who wants to stay invested in real estate but does not want to find and manage another individual building. It can also be a tool for families that need to divide real estate wealth among heirs, as partnership units can be more readily divided than a single apartment property.
Diversification is another part of the appeal. Instead of relying on the performance of a single asset in a single market, the investor can hold units in a vehicle that owns multiple properties. For an owner whose wealth is heavily tied to one multifamily asset, that shift can reduce property-specific concentration, although it introduces exposure to the fund’s strategy, other investments and its sponsor.
The structure may also be relevant to investors coming out of Delaware statutory trusts, which are often used by 1031 exchange investors to acquire fractional interests in institutional real estate. Houtkooper said that as the DST market has grown, a 721 contribution has emerged as one potential path for investors seeking to move from a DST interest into a larger continuation vehicle.
That does not mean a 721 exchange is the best answer for every owner. An investor who wants to maintain direct control over a property, select every replacement asset or retain a specific ownership structure may prefer a conventional sale or 1031 exchange. The value of the 721 option is that it broadens the conversation beyond a simple choice between holding and selling.
What Investors Need To Underwrite
The contributed property is only one part of a 721 transaction. Investors also need to assess the partnership or fund receiving it. That includes the sponsor’s operating record, investment strategy, portfolio composition, leverage, fee structure, governance rights and policies for redemptions or transfers of units.
The change in control is particularly important. A direct owner decides when to refinance, renovate or sell a building. A 721 contributor typically becomes a passive holder of partnership units, leaving those decisions to the manager of the vehicle. That can be a benefit for an owner ready to step back from active management, but it is a meaningful surrender of control.
Liquidity also requires close attention. Some vehicles may offer periodic redemption rights or other mechanisms for transferring units, but those rights vary by structure and may be subject to limitations. A partnership interest should not be viewed as equivalent to a publicly traded stock or a guaranteed source of cash.
For multifamily owners, the growing interest in 721 exchanges reflects a broader shift in the market. More investors are looking at how to transition out of concentrated, hands-on ownership while preserving tax deferral and real estate exposure. A 721 exchange can provide that path, but its usefulness ultimately depends on the quality and terms of the partnership that receives the property.
Source: “The Growing Role Of 721 Exchanges In Multifamily Deals”
