Section 721 of the Internal Revenue Code generally provides that no gain or loss shall be recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership.
Direct 721 Exchange into a Corporate Entity
As an example, let’s say that a couple owns a 50-unit apartment complex. They are nearing retirement and no longer want to actively manage the asset but also do not want to pay the capital gains tax due on the sale of the property. By transferring the property into a real estate LLC corporate entity, the couple can receive units in the corporate entity that may provide cash flow equal to or greater than their net cash flow on the apartment building. By effectuating a 721 exchange into the corporate entity, they can own units in a diversified portfolio of real estate properties that provide cash flow without day to day property management responsibilities.
Disadvantages of a 721 Exchange
The primary disadvantage of a 721 exchange is that once the property owner contributes the property to the entity, they lose the ability to do another 1031 exchange. If they choose to liquidate their interest in the entity, or at any time the entity sells the asset they contributed, they would be subject to capital gains tax at that time. If the property owners hold their shares in the entity until death, their heirs would get a stepped up basis at their death and would not be liable for capital gains tax. However, the proceeds received from the shares would be subject to estate taxes if the proceeds exceed current federal exemptions for estate taxes.
Clients and prospective clients of Welsh Securities, LLC should not construe the contents of this website or any prior or subsequent communications from Welsh Securities or its respective affiliates as legal or tax advice. Each individual investor should consult his or her own counsel, accountant and other advisers as to tax matters concerning such person’s investments.
There are unique risks associated with owning commercial real estate that apply to investors utilizing IRC 1031 and/or IRC 721. These risks include, but are not limited to, loss of property value, real property assets being highly illiquid, risks associated with the general economic climate, local real estate conditions, the markets for leasing, geographic or market concentration, the abilities of managers of the assets and loss of management control in some tenant in common situations, and the use of mortgage financing which creates risk related to fluctuations in interest rates and foreclosure. Additionally, real estate investments may be subject to fees and expenses that impact the performance of the investment, including but not limited to, property management, asset management, financing, brokerage, or facilitation fees.
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