721 Exchange Overview: How to Exit Your Investment Property

Looking to defer your capital gains or depreciation recapture taxes while growing your real estate investments? Look no further than the 721 exchange.

This little-known section of the Internal Revenue Code (IRC) allows owners to defer taxes of a home sale by contributing property to a partnership in exchange for shares.

If you want to increase your liquidity, diversify your investments, and earn no-hassle passive income, you’ll love the 721 exchange.

Unfortunately, most property owners don’t know about it — and if they do, they don’t understand well enough to try it.

We get it, and that’s what we’re trying to resolve with this comprehensive 721 exchange overview. Below, we’ll walk you through:

• What Is a 721 Exchange
• 721 Exchange vs 1031 Exchange
• How a 721 Exchange Works
• Benefits of a 721 Exchange
• How to Get Started

What Is a 721 Exchange?

The 721 exchange lets property owners swap property for shares in a Partnership that owns real estate (it’s also known as an UPREIT). Instead of bearing the hassles and costs of selling your property or hiring a property management company, this section of the IRC lets you grow your investments without upfront expenses or capital gains taxes.

Capital gains and depreciation recapture taxes can eat up 20–30% of the gains made when you sell your home. With a traditional sale, you’ll pay those taxes immediately. With a 721 exchange, you can defer those taxes until you earn distributions or redeem units.

Using the 721 exchange doesn’t help you avoid paying taxes, but it does give you more control over when you pay those taxes. This control helps keep your wealth working for you on your schedule rather than the Internal Revenue Service’s (IRS). It also empowers you to liquidate your assets at will by redeeming shares, which is faster (and more predictable) than selling a home.

When you take advantage of the 721 exchange with Flock, you gain ownership units in a managed portfolio of homes (equal to your contributed equity value). You’ll get ongoing quarterly income from your investment, as well as your stake of appreciation and depreciation from the portfolio. You can redeem your shares piece-by-piece or all at once. You can even pass your shares on to heirs without triggering a taxable event.

721 Exchange Vs. 1031 Exchange: What’s the Difference?

The 1031 exchange helps investors defer capital gains taxes by exchanging their investment property for a “like-kind” asset. This section of the IRC essentially lets you trade your property for another without paying capital gains taxes. You might make a profit on each swap, but you won’t pay taxes until you cash out years down the road.

However, the 1031 exchange doesn’t help investors diversify their assets, earn passive income, or liquidate. You’ll still be responsible for an investment property, and that includes maintaining it, finding tenants, collecting rent, and the like.

1031 exchanges aren’t simple or easy. For example, to qualify, you’ll need to find a replacement property within 45 days of selling your property, and the closing must occur before 180 days following the sale. You’ll also need a qualified intermediary to handle the exchange proceeds. In the end, it’s a lot of costs, stresses, and complications.

Another 1031 structure exists for owners that want to earn passive income, and it’s known as the Delaware Statutory Trust (DST). However, DSTs carry deceptively high fees, and that’s on top of the hassle of selling your property prior to the 1031 exchange. Most DSTs have finite liquidity options and tend to invest in real estate assets with limited appreciation prospects.

The 1031 exchange can be a viable solution for experienced real estate investors, but it’s not the preferable option for landlords looking for a tax-advantaged exit strategy. It’s too riddled with operational hurdles and logistically taxing qualifications.

On the other hand, a 721 exchange lets you trade your property for units in a Partnership. You won’t be responsible for owning and operating your real estate investment anymore, and you’ll earn ongoing income (and accelerated upside potential) while deferring your capital gains taxes. Plus, you diversify your risk by joining a larger pool of investment assets rather than holding on to one.

How Does a 721 Exchange Work?

Here’s how the 721 exchange process works with Flock:

1. Valuation and Offer: Provide a few details about your home and you’ll receive a free, no-obligation home valuation estimate within 24 hours. Like what you see? We’ll set up a discreet, confidential inspection, confirm the valuation, make final adjustments for deferred maintenance (if needed), and give you your offer.
2. Close and Exchange: In less than 2 weeks, we schedule a close to transfer the title and pay off your remaining mortgage. The closing process is similar to a traditional sale, but instead of receiving cash which triggers taxes, you’ll receive shares to keep growing your investment over time.
3. Home Management Hand-Off: We take over all aspects of ownership and property management and honor existing leases. Our fee structure is like a traditional mutual fund — we charge a1% asset management fee annually.
4. Own an Optimized, Diversified Portfolio of Homes: We pay you every quarter, and you get real-time insights into your appreciation value and income. Redeem your units one by one or all at once after a 3 year holding period. You can even pass your units on to an heir without paying taxes.

What Are the Benefits of a 721 Exchange?

So, why would you want to trade your property for shares in a REIT rather than sell the home? Good question. Here are the unique benefits you get with a 721 exchange:

• Hassle-Free: Retire from the responsibilities of being a landlord; no more lease-ups, turns, or late-night maintenance calls.
• Diversification: A single property is at risk of negative cash flow, high vacancies, and area depreciation. When you join a pool of properties, you mitigate risk by diversifying your investment.
• Passive Income: We take over the property management — you sit back, relax, and watch your bank account grow every quarter.
• Tax Deferral: Selling a home isn’t cheap. For starters, you have costly seller and closing fees. Then, you have capital gains and depreciation recapture taxes. A 721 exchange helps you avoid all of that upfront and take more control over your wealth management.
• Liquidity: Homes are considered illiquid assets, meaning this capital is often tied up for an extended period of time before it’s able to be turned into cash. On the other hand, shares can be converted into cash quickly, allowing you to move your money around freely.

Take Advantage of the 721 Exchange With Flock

Selling or renting your home isn’t always the best investment option, and neither is a 1031 exchange — that’s why we offer homeowners a better way to grow their rental investment.

Start the 721 exchange process with Flock by sharing a few details about your home. We’ll send you a free, no-obligation home valuation in the next 24 hours. If you like what you see and want passive income, greater diversification, and more liquidity, we can come by your house and seal the deal.

Have more questions? We have more answers. Learn more about how it all works here.