Section 721 defers taxation for owners of real estate who contribute their property to an OP. The gain that would be recognized in a taxable sale is deferred. The gain is deferred until the owner elects to sell the OP units in a taxable transaction. The owner has the ability to hold OP units indefinitely or time the sale to coincide with tax or financial planning strategies.
The tax deferral becomes permanent (the tax is essentially forgiven) upon death. The heirs, upon death of the OP holder, receive a stepped-up tax basis in the OP units (tax basis equal to fair market value). This means that the heirs can then sell free of taxes (federal and state). In this way, the deferral becomes permanent upon death. Section 721 is a popular alternative to a taxable sale for real estate owners interested in a tax-favored investment with an institutional partner. Note: Tax outcomes depend on individual circumstances— consult a tax advisor.