Rethinking the Exit: A Practical Look at 721 Exchanges for Today’s Rental Property Owners

If you’ve owned rental property for a decade or more, you’ve probably lived through more than your share of renovation bills, unexpected repairs, new tax rules, tenant protections, shifting rent caps, and ever-increasing operating costs. Many of the small and mid-sized owners we speak with today have built real wealth through real estate; not because it was always easy, but because they stuck with it through multiple cycles.

Now, a growing number of these same owners are thinking about what comes next.

Why So Many Owners Are Considering an Exit

Rising expenses are a big reason. National apartment benchmarking data shows repairs and maintenance are up roughly 13.7% year-over-year, driven by higher material and labor costs. Median per‑unit maintenance costs sit around $950 per year, and common budgeting frameworks suggest $0.90–$1.30 per sq. ft. or 1–3% of property value annually.

At the same time, regulatory pressures—rent caps, eviction restrictions, tenant‑protection ordinances—have added new layers of operational complexity, particularly in states like California and New York and in cities like Seattle. These policies can compress income growth and extend the timeline to resolve serious tenant issues.

And then there’s the tax bill associated with selling. Depending on your income, federal long‑term capital gains tax sits at 0%, 15%, or 20%, with many long‑time landlords falling into the 15–20% range. That doesn’t include depreciation recapture or state taxes. For owners who bought decades ago, the appreciation is wonderful—but the tax hit is not.

Put together, it’s no surprise that many owners are asking: “Is there a cleaner way to step back without watching half of my gain evaporate in taxes or leaving my kids with a management project they don’t want?”

Introducing the 721 Exchange

One option worth understanding is the 721 Exchange, which allows you to contribute real estate into an operating partnership (“OP”) in exchange for OP units, rather than selling outright. Under Section 721 of the Internal Revenue Code, this contribution is treated as a tax‑deferred transaction—meaning capital gains tax is deferred, not eliminated, until a future taxable event.

OP units are simply an ownership interest in a private real estate fund—in this case, the HZ Evergreen Fund, a diversified multifamily portfolio. Because the fund is not structured as a REIT (public or non‑traded), these units do not function like REIT shares and can’t be bought or sold on any market. Liquidity is available only during the fund’s two scheduled redemption windows each calendar year.

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

Both 721 and 1031 Exchanges allow for tax‑deferred real estate transitions, but they solve different problems.

1031 Exchange

• You sell your property and reinvest in another “like-kind” property.
• You must meet the 45‑day identification and 180‑day closing rules.
• You maintain direct property ownership, unless using structures like a DST.

721 Exchange

• You contribute property to a partnership instead of selling.
• No 45‑day/180‑day deadlines.
• You shift from landlord to passive owner in a diversified private fund.
• Liquidity, if available, comes through scheduled redemption periods, not public markets.

Some owners even do a two‑step: 1031 into a DST, then later contribute those DST interests into the operating partnership via a 721 Exchange, retaining tax deferral at each step.

Why Estate Planning Is Driving Interest

Talk to any estate attorney and they’ll tell you: heirs often don’t want to inherit a building. They may live out of state, have no property management experience, or simply want liquidity—not a part‑time job.

A single apartment building also cannot be easily divided among multiple heirs without tension. By contrast, OP units are simple to allocate. Like real estate, OP units may also benefit from a step‑up in basis under IRC §1014 at inheritance, which can reduce future capital gains taxes for your heirs. To support this, the fund provides quarterly valuations, which assist in the precise calculation of the step‑up in basis at the time of transfer.

For many families, this avoids the common “what do we do with the property?” disagreements that show up during transitions.

A Real‑World Example

Consider a long‑time owner in San Jose who bought a 10‑unit property in the early 2000s. The building appreciated significantly, but so did maintenance costs—new HVAC systems, rising insurance premiums, and a major exterior repair delayed for years. With California’s rent caps tightening and eviction processes growing more complex, NOI growth slowed.

The owner’s adult children lived in three different states and had no desire (or alignment) on how to manage the property. Instead of selling and triggering a large tax bill, the owner contributed the property via a 721 Exchange into a diversified private multifamily fund. They transitioned from hands‑on management to passive income, deferred capital gains tax, and left their heirs with private‑fund units—something far easier to divide than a building.

Is a 721 Exchange Right for You?

It might be worth exploring if you:

• Own appreciated rental property and wish to defer taxes
• Are ready to retire from active management
• Want exposure to diversified multifamily instead of a single building
• Prefer to leave heirs a simpler, more liquid asset
• Are concerned about escalating maintenance or shifting regulatory constraints

This isn’t the right structure for everyone—but for many owners in transition, it’s an underutilized tool.

Closing Thoughts

The 721 Exchange is not a loophole or a trend. It’s a long‑standing provision of the tax code that provides real flexibility for owners who have spent years building wealth through real estate and want a smoother, more tax‑efficient, family‑friendly exit.

If you’re evaluating long‑term options or simply want to understand the 721 Exchange more deeply, we’ve created a comprehensive educational page you can review anytime at: https://hamiltonzanze.com/721-exchange

As always, speak with your CPA and legal advisors before making any decisions.

This article was originally published in REI INK >>