The Third Option Most Sellers Have Never Heard Of

He built two mobile home communities into a $14 million sale. Then he ran the tax math and almost didn't pull the trigger. What he didn't know is that there's a way to exit a real estate investment without writing a seven-figure check to the IRS, and without starting the 45-day clock of a 1031 exchange. Here's how it works, why most investors have never heard of it, and when it actually makes sense.

I was talking to a friend of mine last week. He owns two mobile home communities he's been building for years. Bought them when nobody wanted them. Did the work. Stabilized the income. Pushed rents to market. Cleaned up deferred maintenance. The two assets are now worth roughly $14 million on the open market, and he's ready to sell.

Then he said something I hear from sellers constantly. "What's the point of selling if I have to give half of it to the government?"

He felt stuck. He didn't want to do a 1031 exchange, because very few deals on the market right now are worth buying at the cap rates being offered. And he didn't want to manage another asset. But he also couldn't stomach paying the tax bill if he took the cash.

What he didn't know is that he had a third option. And it's one many real estate investors, even experienced ones, may have never heard of.

Why this seller had real equity to protect in the first place

Before we get to the third option, it's worth understanding why his situation matters. He didn't get to $14 million by accident, and he didn't get there by buying at the stated cap rate on a broker's offering memorandum.

Most listings inflate the cap rate using four assumptions that almost never hold up under operation.

Rent growth that hasn't happened yet. The model assumes market rents on units that are currently vacant or sitting on old, below-market leases. You're being asked to pay for the leasing work before it's been done.

Property taxes that haven't been reassessed. The seller's tax bill goes in the model. The moment you close, the assessor reassesses at your purchase price. On a meaningful asset, that's six figures of new annual expense the OM never showed you.

No real property management cost. A lot of sellers manage their own properties. There's no management fee, no onsite manager, no maintenance payroll on the books. When a professional operator takes over, all of that becomes real money.

No capital expenditure, infill, or leasing downtime. The model often assumes full occupancy, little to no turnover cost, and no deferred maintenance, if any. Reality is different.

My friend understood all four of those assumptions because he'd been on the receiving end of them when he bought. He paid attention to in-place income. He underwrote real operating expenses. He calculated yield on cost, not stated cap rate.

That discipline is what built his $14 million in equity. Which is exactly why protecting it on the way out matters as much as creating it on the way in.

The tax bill on a $14 million sale could be worse than most sellers realize

Here's what he was running in his head. $14 million sale, federal long-term capital gains rate around 20%, plus net investment income tax, plus state. He was budgeting roughly two and a half million in taxes and trying to figure out if he could live with that.

The actual number could be worse. Sometimes a lot worse.

Early in his ownership of these communities, he used Section 1245 bonus depreciation. He accelerated depreciation in the first few years to offset other income. It was a smart strategy at the time and saved him a meaningful amount of tax.

Here's the catch. When you sell, that depreciation gets recaptured. And bonus depreciation recapture on personal property components isn't taxed at the capital gains rate.

It's taxed as ordinary income. At rates up to 37% federal. Add state income tax on top, and the effective rate on that portion of the gain can approach 40%. Of course, it's worth discussing such a situation with a professional tax advisor.

But, the actual tax outcome depends on his basis, how much depreciation was taken, what type, and his state of residence. And on a sale of this size, with this depreciation history, the total tax bill could realistically land somewhere between $3 and $5 million. Not the $2.5 million he was budgeting.

That's the number that made him stop and call me.

The option he already knew about, and why it wasn't solving the problem

Most real estate investors know about the 1031 exchange. You sell, you have 45 days to identify a replacement property and 180 days to close. The gains get deferred. You keep rolling forward.

The 1031 is a powerful tool. We use it ourselves at Patriot when the right opportunity is in front of us or our partners. But for this specific seller, in this specific market, it wasn't the answer.

Two reasons.

First, he didn't want to find another asset to manage. He's done. He's built what he set out to build, and he wants the work to be over. A 1031 forces him right back into operating real estate.

Second, the 45-day clock creates real pressure to make a decision. And pressure doesn't always result in a great buy. In a market where the right deals are scarce and pricing is still adjusting, having to identify a target in six weeks is a setup for potentially overpaying.

So he felt like his only two real options were paying a multi-million-dollar tax bill, or running back into the situation he was trying to exit.

That's when I told him there were two more options he didn't know existed.

Option three: the 721 exchange, also called an UPREIT

A 721 exchange lets you contribute your property to a publicly traded REIT in exchange for operating partnership units, called OP units, in that REIT.

No cash changes hands at the contribution. No taxable event at the moment of the exchange. The equity in your property becomes units in the REIT, and the embedded tax liability rolls into the basis of those units.

Those units pay distributions. They're generally liquid, meaning you can convert them to publicly traded REIT shares over time on a schedule that fits your tax planning. And you're done operating real estate.

The catch on a 721 exchange is that the public REIT has to actually want your specific property. They're looking for assets that fit their portfolio strategy, their geography, and their scale. If you own a small or mid-size asset, or an asset that doesn't match their thesis, you're not getting that conversation.

Which is where the fourth option comes in.

Option four: a 721 contribution into a private real estate fund

Same mechanics. Same tax treatment. But instead of contributing into a public REIT, you contribute your property into a private fund. This is the structure we offer at Patriot Holdings, and we've worked with investors through it before.

Here's what it looks like in practice.

He contributes his two communities into our fund. We issue him a special class of LP units that represent his equity. No cash is exchanged at contribution. The capital gains and recapture liability is deferred into the basis of those LP units, not recognized at the moment of exchange.

Instead of owning two properties, he now owns a piece of a diversified portfolio of more than 20 assets across multiple asset classes and markets. Professionally managed. He's not taking tenant calls. He's not approving capital expenditure budgets. He's not signing leases.

And he receives passive distributions from the fund's cash flow, paid out on the fund's regular distribution schedule.

What the numbers actually look like

Let's put concrete figures on it.

$14 million sale, taken in cash. After capital gains tax, recapture on the bonus depreciation, and state income tax, the realistic net proceeds land somewhere between $9 and $11 million depending on his basis, depreciation history, and state.

$14 million contributed into a 721 structure. The full $14 million stays invested. Distributions are calculated on the full equity amount, not on the after-tax remainder.

That delta, $3 to $5 million dollars working for him instead of being paid in tax, is the entire game.

And there's a second piece most sellers miss. Under current tax law, if he holds those LP units until he passes away, his heirs receive a step-up in basis on the inherited units. The deferred capital gains and recapture liability disappears at that point.

This is current tax treatment and could change with future legislation, so it should never be the only reason to do a transaction. But for an investor who's already in the estate planning phase of their life, it's a material consideration.

When a 721 contribution is not the right answer

I want to be clear about something. The 721 contribution is not a fit for every seller, and anyone who tells you it is doesn't understand the structure.

It's the right tool when you want to be done operating real estate, you want diversification across multiple assets instead of concentration in one or two, you want passive income on your full equity base, and you have an estate plan where deferral plus a future step-up in basis aligns with your goals.

It's the wrong tool if you want full liquidity immediately, if you have a clear replacement property already identified for a 1031, if you need to access principal in the near term, or if your specific property doesn't fit the receiving fund's portfolio strategy.

Like any tax-advantaged structure, it has constraints. The work is figuring out whether your specific situation fits inside those constraints.

The point

The 721 exchange and the 721 contribution are not loopholes. They're provisions written into the tax code to incentivize long-term real estate investment, and they've been used by sophisticated investors and institutions for decades. The reason most individual sellers have never heard of them is that they're rarely advertised, and they require a CPA who specializes in real estate and an attorney who has actually structured these transactions before.

If you're a real estate investor thinking about selling, the question isn't whether to do a 1031 or write a check to the IRS. The question is which of four options fits your situation. A sale, a 1031, a 721 exchange into a public REIT, or a 721 contribution into a private fund.

Pick the wrong tool and you either overpay in tax or run back into a problem you were trying to leave behind. Pick the right one and the $14 million stays $14 million, working for you on the terms you actually want.

"The 721 exchange and 721 contribution aren't loopholes. They're advantages built into the tax code to incentivize long-term real estate investment. The reason most sellers have never heard of them is that they're rarely advertised, not that they don't exist."

Jeremiah Boucher, Founder & CEO, Patriot Holdings

If you're considering a sale and the tax bill is keeping you up, we'd love to have a conversation.

We've worked with sellers through 721 contributions before, and we're happy to walk through whether your situation might fit. There's no pressure and no pitch. If a 1031 or a straight sale is the better answer for you, we'll tell you that. And, we may be able to help there too. If a 721 structure is worth a deeper conversation with your CPA and attorney, we can show you what that looks like. For those considering a 1031, we're happy to explore how we might help support a future replacement.

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This content is for informational and educational purposes only and does not constitute tax, legal, or investment advice. Tax outcomes depend on individual circumstances including basis, depreciation history, state of residence, and current tax law. Consult a qualified CPA and attorney before structuring any transaction. Patriot Holdings does not guarantee any specific tax or investment result.