Section 721 and like-kind exchanges under Section 1031 of the Internal Revenue Code provide powerful ways for investors and business owners to defer taxes when transferring property or partnership interests. Both strategies allow you to delay paying capital gains or other taxes until a later taxable event, such as selling the partnership interest or replacement property. Understanding how these rules work after the 2017 Tax Cuts and Jobs Act (TCJA) is crucial for effective tax planning.
What Is Section 721 and How Does It Work?
Section 721 allows a property owner to contribute property to a partnership without recognizing immediate gain or loss. This means when you transfer property—whether real estate, equipment, or intangible assets—to a partnership, you receive a partnership interest in return. The partnership takes the property at your original carryover basis, and the tax liability is deferred until you sell your partnership interest or the partnership sells the property.
This provision is vital for business owners forming partnerships or pooling assets, allowing flexibility in reorganizations, mergers, or joint ventures without upfront tax consequences. Note that Section 721 applies only to property contributions—not to cash or services.
Overview of Like-Kind Exchanges Under Section 1031
Before the TCJA, like-kind exchanges under Section 1031 allowed taxpayers to defer gains on exchanging virtually any type of property, provided the replacement asset was similar in nature. However, the 2017 tax reform narrowed the scope drastically.
Currently, Section 1031 exchanges are limited to real property only—such as exchanging one rental house for another real estate investment property. Personal property, including machinery, vehicles, or intangible assets, no longer qualifies for like-kind exchange treatment.
To qualify, the properties involved must be held for investment or business use, and the exchange must meet strict IRS rules including identification and acquisition timelines, usually managed by a qualified intermediary.
Key Changes After the 2017 Tax Reform
- Section 721 remains largely unaffected, still allowing tax-deferred property contributions to partnerships.
- Section 1031 exchanges are restricted exclusively to real estate.
- Personal property like equipment or vehicles no longer qualifies for 1031 treatment.
These changes mean that investors in personal property now face immediate tax recognition upon sale or exchange, while real estate investors retain the deferral benefits with proper compliance.
Practical Examples
Section 721 Example: Jane contributes a commercial building to a real estate partnership. She receives partnership shares without paying tax immediately. When she later sells these shares, she recognizes any gain.
Section 1031 Example: Bob trades a rental house for a commercial property. Because both are real estate, he defers capital gains tax under Section 1031. However, if Bob tried to exchange a truck for a building, it would not qualify post-TCJA.
Who Benefits?
- Business owners and investors consolidating or forming partnerships benefit from Section 721’s tax deferral.
- Real estate investors engaging in property swaps use Section 1031 to defer capital gains.
Tax Planning Tips
- Consult a tax professional before property contributions or exchanges.
- Use a qualified intermediary for 1031 exchanges to meet IRS deadlines and requirements.
- Keep detailed records of your property’s original basis to track future tax implications.
- Remember that tax is deferred, not eliminated; plan accordingly.
Common Misconceptions
- Section 721 defers taxes indefinitely: Taxes are deferred until the partnership interest or property is sold.
- 1031 exchanges apply to all property types: Only real property qualifies after 2017.
- Deadlines are flexible: Missing IRS timelines for 1031 exchanges triggers immediate tax liability.
Comparison Table: Section 721 vs Like-Kind Exchanges (Section 1031) Post-TCJA
| Feature | Section 721 | Section 1031 Like-Kind Exchange |
|---|---|---|
| Applies to | Property contributions to partnership | Exchanges of like-kind real estate only |
| Tax Trigger | Sale of partnership interest or property by partnership | Sale of replacement real estate |
| Tax Deferral | Yes | Yes |
| Eligible Property Types | Real and personal property | Real property only |
| Common Use | Forming or joining partnerships | Real estate investment exchanges |
For further details on 1031 exchange timelines and required procedures, see our glossary articles on 1031 Exchange and Qualified Intermediary in a 1031 Exchange.
Authoritative Sources
- IRS Notice 2018-59: Guidance on Like-Kind Exchanges after TCJA irs.gov
- IRS Publication on Like-Kind Exchanges IRS.gov – Like-Kind Exchanges
Understanding Section 721 and like-kind exchanges empowers investors and business owners to defer tax liabilities strategically after recent tax reforms. Careful planning and adherence to IRS rules ensure these tools remain effective in optimizing your financial and tax outcomes.