What does free out-of-system subway transfer mean on the NYC MTA?

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It means that you can transfer between two separate subway stations without paying another fare. You will have to swipe your Metrocard again, but you'll get a free transfer, instead of having another fare deducted from the card.

The best (really the only) example of a free out-of-system transfer that I can think of is the 59th Street-Lexington Avenue station on the 4-5-6 and N-R-Q lines, and the 63rd Street-Lexington Avenue station on the F train. These are two completely separate stations that are not connected in any physical way. To get from one to the other, you have to exit the subway system and walk on the street. When you get to the other station, you have to swipe your Metrocard and go through the turnstile again, but your card will get a free transfer.

The free out-of-system transfer differs from the free in-system transfer in that the two stations you are transferring between are not physically connected to each other by a tunnel or passageway. You have to exit the system (go out through the turnstiles) and then go back in through the turnstiles at the other station.

There are plenty of stations that offer free in-system transfers, for example, the 42nd Street-Port Authority station on the A-C-E line, and the 42nd Street-Times Square station on the 1-2-3, N-R-Q, and 7 lines. These are two different stations, but they are connected by an underground passageway, so you can transfer without going through the turnstiles and exiting the subway system.
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