Buy, Borrow, Die With a 1031 at 7% Rates, and What a 721 Does When Everyone Wants Out

What buy, borrow, die is, and what 7% does to it

Buy, borrow, die avoids income tax by avoiding a sale. You hold an appreciated asset, borrow against it for living expenses, and at death your heirs take a fair market value basis under IRC 1014, so the built-in gain is not taxed.

Interest is the cost of that choice, and at 7% it is not small. Borrowing $2,000,000 costs $140,000 a year in interest. If the interest is paid from the asset's income, the loan stays at $2,000,000.

If it is rolled into the balance, $2,000,000 becomes about $3,934,000 in ten years.

The asset has to outrun the loan. Appreciation below 7% a year on the borrowed amount means the debt is growing faster than the collateral behind it. Whether the interest is deductible depends on what the money is used for, and borrowing to spend on living costs is generally not deductible. A tax professional should state the rule for your facts in writing.

Where the 1031 fits

A 1031 exchange defers the gain when real property is swapped for other real property, and it can be repeated. That keeps you in an asset a lender will lend against, which is the borrow step. The 1031 does not remove the gain.

It carries the old basis into the new property, and the step-up at death is what finally erases it. Debt matters inside the exchange too: paying down debt or receiving cash is boot and is taxed now.

What a 721 changes

A Section 721 contribution to a REIT's operating partnership defers the gain in exchange for units. Two things change for a buy, borrow, die plan. First, units are partnership interests, not real property (Treas. Reg. 1.1031(a)-3(a)(5)), so you can never 1031 again.

Second, the asset you would borrow against is now a unit that a lender may value at a discount or not accept at all, and the partnership agreement may limit pledging. Check both before the contribution, not after.

Income from the units usually replaces rent, which can pay the interest. But the units also tie your tax to the partnership: if it sells the property you contributed, the original built-in gain can be allocated back to you under Section 704(c) unless you have a tax protection agreement, and those are time-limited.

Taking small pieces of a 721

The cash path out of units is redemption. Redeeming units for cash, or exchanging them for REIT shares and selling, is generally a taxable sale of the units (IRC 731 and 741). Gain is recognized in proportion to what you redeem.

On a $2,000,000 deferred gain, redeeming one-fifth of the units in a year recognizes about $400,000 and leaves $1,600,000 deferred, with the depreciation-recapture share riding along. Spread over several years, small redemptions can keep each year's income, and brackets, lower than a single large exit.

Our REIT exchange page runs that math for five years of one-fifth redemptions.

This only works if the sponsor lets you redeem in pieces when you want to. That is the liquidity question.

If everyone redeems at once, is a 721 liquid?

Not by right. A redemption program is a policy of the sponsor, usually subject to board discretion. The SEC's Office of Investor Education says nontraded REIT redemption programs are typically subject to significant limitations, can be discontinued without notice, and may redeem at a discount to value (Investor Bulletin: Non-traded REITs).

The nearest real example is Blackstone's BREIT, a nontraded REIT. Its repurchase plan allowed up to 2% of net asset value in a month and 5% in a quarter.

In October 2022 it received repurchase requests equal to 2.7% of NAV, about $1.8 billion, and in November repurchased about $1.3 billion, the 2% limit and about 43% of each investor's request. Unfilled requests were not carried over automatically (InvestmentNews).

BREIT is not your 721 partnership, and its terms are its own, but it shows the pattern: the demand for cash is highest when the market is worst, and the cap is what binds.

Run risk is worse for a buy, borrow, die plan because you may have a loan payment due. If the sponsor prorates your request, you get part of the cash, the loan still needs paying, and the rest of your request may have to be resubmitted.

Can a sale be forced on you?

Yes, in several ways, and most are decided by the sponsor. A merger can convert units to shares or cash on the buyer's timetable. A sale of the property you contributed can allocate your built-in gain to you (Section 704(c)).

A sponsor may settle redemptions in shares rather than cash. Some Delaware statutory trust programs convert into a REIT at the sponsor's option. None of these needs your consent, so read the operating agreement before you sign.

Questions to put to the sponsor in writing

1. Is the 721 contribution mandatory or optional, and who decides?
2. What are the monthly and quarterly redemption caps, and what happens to a request that is not filled?
3. Are redemptions paid in cash, REIT shares, or at the sponsor's choice?
4. Is there a lock-up, and how long does a tax protection agreement last?
5. Can the program be suspended, and can units be pledged to a lender?
6. What happens to my units in a merger?

How much tax would you owe? Run your own numbers

Frequently asked questions