Rules to Remember When Doing a 721 Exchange

A 721 exchange is a powerful tool that can save you tax dollars while allowing you to diversify your portfolio. You can also use a 721 exchange as an exit strategy often overlooked by real estate investors. It’s a tax-deferred exchange that enables you to exchange one kind of property for another without incurring any immediate tax liability. However, it’s important to know the rules when doing a 721 exchange. To help you navigate the process easily, we’ve compiled a list of things to remember.

It Must Be Like-Kind

First and foremost, you must remember that the exchange needs to be like-kind. This means the property you’re exchanging must be similar. It doesn’t need to be an exact match but must be a similar investment type. For example, you could exchange an office building for a retail building or land for a rental property. But you can’t exchange real estate for stocks or bonds.

There Are Strict Timelines

Timing is everything. The 721 exchange has strict timelines you must adhere to, or you risk losing the tax-deferred status. You have 45 days to identify a replacement property but only 180 days to close on the replacement property. This timeline can be challenging, especially since finding a suitable replacement property can be time consuming. Be sure to work with experienced professionals who can help you streamline the process and meet deadlines.

Check Eligibility

You need to be eligible for a 721 exchange. To qualify, you must be an accredited investor. This means you must meet certain financial criteria the SEC has established. This criteria typically includes at least a $1 million net worth or an income of at least $200,000 for the past two years. 

The property you’re exchanging must also be for investment purposes, not personal use. For instance, you cannot exchange your primary residence for a commercial building.

You Need To Know the Tax Consequences

Be aware of the tax consequences. Although a 721 exchange allows you to defer the tax liability, it doesn’t eliminate it. When you eventually sell the replacement property, you’ll be subject to capital gains tax. However, holding the property long enough may qualify for long-term capital gains tax rates, which are typically lower than short-term rates.

A 721 exchange can be a lucrative way to diversify your portfolio while deferring taxes, but you must remember the rules that come with it. Be sure to work with experienced professionals who can guide you through the process and help you meet the stringent timelines. Remember the rules we’ve covered, and you’ll be well on your way to a successful 721 exchange.