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Capital gains taxes can significantly reduce the profits from selling valuable assets like farmland. These taxes, which range from 0% to 20% depending on income levels, can pose challenges for individuals trying to preserve their wealth and transition property ownership. Fortunately, strategies like the 721 exchange provide a way to defer these taxes, offering flexibility and long-term financial planning opportunities.

Ethan Branscum, managing partner of the Sower Legacy Farmland Fund, explains the significance of understanding tax deferral strategies for farmland owners. “When people talk about selling their land, their biggest concern is often, ‘How much capital gains will I owe?’ A 721 exchange can change the conversation entirely by offering a tax-deferral solution.”

This article explores the 721 exchange, its benefits, how it works, and when it might be a valuable tool for farmland owners.

What Is a 721 Exchange?

The 721 exchange is a tax-deferral strategy enabled by Section 721 of the Internal Revenue Code. It allows property owners to exchange real estate assets for partnership units, akin to stocks, in a fund or partnership. Instead of selling farmland and incurring immediate capital gains taxes, the owner contributes the property to a partnership and receives units in return. These units can be retained, gifted, sold, or used as collateral, making them a flexible financial tool.

721 Exchange

To be eligible for a 721 exchange, the property must consist of real estate, such as farmland or commercial property.

“Think of it like this,” Branscum explains. “If you sell a farm and get cash, you’re familiar with the idea of using that cash to purchase a REIT or similar investment. The 721 exchange eliminates that middle step—you’re going directly from farmland to units in a partnership, deferring taxes along the way.”

This process not only defers taxes but also allows for professional management of the property through a diversified fund, which can be particularly useful for landowners facing family disputes or estate planning challenges.

1031 vs. 721 Exchange

The 1031 exchange is better known among landowners. It involves selling one property and reinvesting the proceeds into another like-kind property, with strict deadlines for identifying (45 days) and closing (180 days) on the replacement property. While this is a strong option for those wishing to continue landownership, it can be restrictive and time-intensive.

In contrast, the 721 exchange transitions ownership from real estate to partnership units. As Branscum puts it, “A 1031 exchange swaps land for land, while a 721 exchange swaps land for a partnership interest in a fund that owns land. It’s about liquidity and flexibility.”

721 exchange farmland

A 721 exchange, allowed under Section 721 of the Internal Revenue Code, lets property owners defer taxes by swapping real estate for partnership units (similar to stocks) in a fund or partnership.

The DST (Delaware Statutory Trust), a popular 1031 vehicle, offers fewer opportunities for liquidity or customization. “DSTs are tied to 1031 money and come with stricter rules for exiting,” Branscum explains. “A 721 exchange, on the other hand, lets you liquidate your units gradually or hold onto them for the long term.”

How Does a 721 Exchange Work?

The Process

  1. Contribute Property: A landowner transfers ownership of their real estate asset into a partnership.
  2. Receive Units: In exchange, the landowner receives partnership units equal in value to the contributed property.
  3. Management by Fund: The fund assumes responsibility for managing the asset, handling leasing, improvements, and operational decisions.
  4. Flexible Use of Units: The units can be held to appreciate in value, liquidated in portions, or used for succession planning.

For example, a Midwest farmer recently worked with Sower to resolve a family inheritance issue. “The farmer was one of five siblings and the only one still working the land,” Branscum shares. “His siblings wanted to sell, but he couldn’t afford to buy them out. By using a 721 exchange, the siblings received partnership units they could liquidate later, and he retained the lease on the farmland. It’s a win-win.”

721 Exchange Rules

To qualify for a 721 exchange:

  • The property must be real estate, such as farmland or commercial property.
  • Ownership transfers must align with IRS guidelines, and the property title should be clear of disputes or liens unless properly handled by the fund.

721 Exchange Pros and Cons

Pros:

  • Tax Deferral: No immediate capital gains taxes, allowing owners to retain the full value of their investment.
  • Liquidity: Units can be sold over time or used as collateral for loans.
  • Estate Planning: Units are easier to divide among heirs than physical farmland.
  • Professional Management: Funds like Sower manage all aspects of the property, relieving owners of operational burdens.

Cons:

  • Management Fees: Funds charge fees for management and operations, reducing overall yield.
  • Yield Trade-off: Landowners who previously rented their farmland may see a slightly lower return due to fund fees.
  • Limited Asset Control: Operational decisions are made by the fund, not the original landowner.

Section 721 Exchange Final Thoughts

The 721 exchange is an innovative, albeit underutilized, tool for farmland owners. It provides a streamlined way to defer taxes, simplify inheritance planning, and transition out of direct land management while preserving long-term value. Branscum believes this tool can play a critical role in estate planning and family succession. “Land is a gift to the next generation, but without the right planning, it can become a burden,” he says. “This fund keeps families connected to their land while solving common financial and logistical challenges.”

This strategy isn’t one-size-fits-all, and consulting with estate planners and tax advisors is crucial. But for those facing complex family dynamics, succession planning, or the need for liquidity, the 721 exchange offers a path forward.

“Ultimately, this is about retaining the value of your asset while gaining flexibility,” Branscum concludes. “For families and landowners looking to secure their legacy, this could be the solution they’ve been waiting for.”