The 1031 exchange and the 721 exchange are often mentioned together, and both defer capital gains tax — but they're fundamentally different strategies leading to very different outcomes. A 1031 exchange trades your property for other like-kind real property, keeping you in direct real estate ownership with the flexibility to exchange again. A 721 exchange contributes your property to a REIT's operating partnership for units, moving you into REIT ownership — generally a one-way transition that offers diversification and liquidity but gives up the ability to exchange again. Choosing between them (or using them in sequence) depends on your goals: staying in direct real estate versus transitioning into a REIT. There's even a powerful combination — the 1031-then-721 path — that uses both. This guide compares the 1031 and 721 exchanges, their key differences in control, liquidity, diversification, and flexibility, and when to use each.
The core difference
The core difference between the 1031 and 721 exchanges is what you exchange into and end up holding. A 1031 exchange trades like-kind real property for other like-kind real property — you exchange your property for another individual property (or properties), ending up holding direct real estate. A 721 exchange contributes your property to a REIT's operating partnership for OP units — you end up holding a partnership interest (units in the REIT's operating partnership), not direct real estate.
This difference cascades into everything else. Because a 1031 keeps you in direct real property, you retain the characteristics of direct ownership (control, the ability to 1031 again) and can keep exchanging real property indefinitely. Because a 721 moves you into REIT units (a partnership interest), you gain the characteristics of REIT ownership (diversification, liquidity, passivity) but lose the ability to 1031 (units aren't real property) — generally a one-way move.
So the core difference is direct real property (1031) versus REIT units (721) — which drives the differences in control, flexibility, liquidity, and diversification that follow. The 1031 keeps you a direct property owner; the 721 makes you a REIT investor. The core difference between the 1031 and 721 exchanges — exchanging into like-kind real property (1031, staying in direct real estate) versus contributing to a REIT for units (721, moving into REIT ownership) — is the fundamental distinction from which all the other differences flow. Understanding this core difference is the starting point for comparing the two and choosing between them. The 1031 and 721 lead to fundamentally different places: direct real estate or REIT ownership.
What each defers and how
Both exchanges defer the capital gains tax, but through different code sections and mechanisms. The 1031 exchange defers gain under Section 1031 by exchanging like-kind real property — the gain carries over into the replacement property's basis. The 721 exchange defers gain under Section 721 by contributing property to a partnership for an interest — the gain carries over into the OP units' basis. So both use carryover basis to defer the gain, but under their respective provisions and into their respective holdings (replacement property vs. OP units).
Both also share the step-up benefit: holding the replacement property (1031) or the OP units (721) until death can erase the deferred gain via the step-up in basis. So both can ultimately avoid the gain through the step-up, making both powerful tax and estate-planning tools. The deferral and step-up are common to both, reflecting their shared purpose of deferring (and potentially eliminating) the gain.
The difference in 'how' is the transaction: a 1031 is an exchange of like-kind real property (with deadlines — 45/180 days — and a qualified intermediary), while a 721 is a contribution to a partnership (no like-kind requirement or 45/180 deadlines, but the property must be one the REIT will accept). So the mechanics differ (1031's deadlines and QI vs. 721's partnership contribution), even though both achieve deferral. What each defers and how — both deferring capital gains via carryover basis (1031 under Section 1031 into real property, 721 under Section 721 into OP units), both offering the step-up, but through different mechanics (1031's like-kind exchange with deadlines and a QI vs. 721's partnership contribution) — shows their shared deferral purpose and different mechanics. Both defer the gain and offer the step-up, but via different provisions and transactions. Understanding what each defers and how clarifies their tax similarity and mechanical difference.
Both defer gain via carryover basis and both offer the step-up at death — but the 1031 trades real property (with 45/180-day deadlines and a QI), while the 721 contributes property to a partnership for units.
Control and flexibility
Control and flexibility differ sharply between the two. With a 1031 exchange, you retain control — you own the replacement real property directly, making the decisions (management, financing, when to sell or exchange). And you retain flexibility — you can do another 1031 with the replacement property, continuing to exchange real estate indefinitely, repositioning as your goals change. So the 1031 keeps you in control and flexible, able to keep trading real property.
With a 721 exchange, you give up control — you hold OP units in the REIT's operating partnership, with the REIT managing the properties and making the decisions; you're a passive unit holder without control over the real estate. And you lose flexibility — you generally can't do a 1031 with OP units (they're not real property), so the 721 is typically a one-way move; you can convert units to shares (taxable) or hold them, but you can't exchange back into direct real estate via 1031. So the 721 gives up control and flexibility.
This is a major consideration: the 1031 preserves your control and your ability to keep exchanging, while the 721 trades these away for the benefits of REIT ownership (diversification, liquidity, passivity). For an owner who values control and flexibility (staying in direct real estate), the 1031 fits; for one ready to give these up for REIT benefits, the 721 fits. Control and flexibility — retained with the 1031 (direct ownership, able to exchange again) but given up with the 721 (passive REIT units, generally a one-way move) — are a key difference. The 1031 keeps you in control and flexible; the 721 trades these for REIT ownership's benefits. Understanding this trade-off is central to choosing between them, since it reflects whether you want to retain direct-ownership control and flexibility or transition into passive REIT ownership.
Liquidity and diversification
Liquidity and diversification favor the 721 exchange, which is much of its appeal. A 1031 exchange keeps you in direct real estate, which is illiquid (selling takes time and is all-or-nothing) and often concentrated (you own specific properties). While you can diversify across multiple replacement properties in a 1031, direct real estate remains relatively illiquid and requires effort to diversify. So the 1031 doesn't inherently provide liquidity or broad diversification.
A 721 exchange, by contrast, provides both. The OP units are convertible into REIT shares, which (for public REITs) are liquid — tradable on the market, sellable in portions — giving you a path to liquidity that direct real estate lacks. And the units represent a stake in the REIT's entire diversified portfolio (many properties, types, markets), providing instant diversification that a single property (or even several) can't match. So the 721 offers liquidity (via convertible units) and diversification (the REIT's portfolio) that the 1031 doesn't inherently provide.
This is the 721's key advantage over the 1031: for an owner wanting liquidity and diversification, the 721's REIT units deliver both, while the 1031's direct real estate doesn't. The trade-off (as noted) is control and flexibility, which the 721 gives up. So liquidity and diversification are reasons to choose the 721, weighed against the control and flexibility reasons to choose the 1031. Liquidity and diversification — provided by the 721 (convertible REIT units offering liquidity and a diversified portfolio) but not inherently by the 1031 (illiquid, concentrated direct real estate) — are key advantages of the 721 exchange. For owners wanting liquidity and diversification, the 721 delivers both, which the 1031 doesn't. Understanding this difference, weighed against the control/flexibility trade-off, is central to choosing between them. The 721 buys liquidity and diversification at the cost of control and flexibility.
The one-way door of 721
A critical consideration in choosing the 721 exchange is its one-way nature — once you do it, you generally can't reverse it via 1031. Because OP units are a partnership interest (not like-kind real property), you can't do a 1031 exchange out of them; your options are to hold them (deferred), convert to REIT shares (taxable), or hold until death (step-up). So the 721 exchange is typically an endpoint — a commitment to REIT ownership rather than a reversible step.
This one-way door matters because it's irreversible (tax-free): you can't change your mind and 1031 back into direct real estate without triggering tax (by converting units to shares/cash first, recognizing the gain). So the decision to do a 721 exchange should be made with the understanding that it's generally a final transition into REIT ownership, not a temporary or reversible move. This contrasts with the 1031, which keeps your options open (you can keep exchanging real property).
The one-way nature isn't necessarily a drawback — for an owner who wants to commit to REIT ownership (for diversification, liquidity, passivity, estate planning), the finality is fine, even desirable (it's the intended endpoint). But it's a crucial consideration to understand before doing a 721 exchange, since you're committing to REIT ownership. The one-way door of 721 — the generally irreversible nature of the move into REIT units (you can't 1031 out tax-free) — is a critical consideration in choosing the 721 exchange. It means the 721 is an endpoint, a commitment to REIT ownership, not a reversible step. Understanding the one-way door ensures you choose the 721 exchange knowing it's a final transition, which suits owners ready to commit to REIT ownership but not those wanting to keep their options open. The finality is the defining trade-off of the 721 versus the 1031's continued flexibility.
- Core difference: a 1031 trades like-kind real property (staying in direct real estate); a 721 contributes property to a REIT for units (moving into REIT ownership).
- Both defer gain via carryover basis and offer the step-up at death, but through different code sections and mechanics.
- The 1031 keeps control and flexibility (can exchange again); the 721 offers liquidity and diversification but is generally a one-way move.
- A powerful combination is the 1031-then-721 path — exchanging into a DST, which is later UPREIT'd into a REIT via a 721 exchange.
When to use each (and the 1031-then-721 path)
Choosing between the 1031 and 721 — or using them together — depends on your goals. Use a 1031 exchange when you want to stay in direct real estate — retaining control and the flexibility to keep exchanging, repositioning among properties, building or trading your portfolio. The 1031 fits owners who want to remain active (or semi-active) direct real estate investors, deferring tax while keeping their options open. So the 1031 is the choice for continued direct real estate ownership.
Use a 721 exchange when you want to transition into REIT ownership — gaining diversification, liquidity, and passivity, especially for estate planning, and you're ready to commit to that (accepting the one-way nature and loss of control). The 721 fits owners ready to exit direct real estate into a diversified, passive, more liquid REIT, as an endpoint. So the 721 is the choice for transitioning out of direct real estate into REIT ownership.
A powerful combination is the 1031-then-721 path. An investor does a 1031 exchange into a DST (deferring the gain, gaining passive real estate), and later, when the DST's property is acquired by a REIT (via a 721 exchange, sometimes a planned 'UPREIT exit'), the investor's DST interest is converted into OP units — transitioning from direct property, through a DST, into REIT ownership, all tax-deferred. This path combines the 1031 (into the DST) and the 721 (into the REIT), letting an owner ultimately reach diversified, liquid REIT ownership tax-deferred. When to use each — the 1031 for staying in direct real estate (control, flexibility), the 721 for transitioning into REIT ownership (diversification, liquidity, passivity, estate planning), and the 1031-then-721 path for reaching REIT ownership through a DST — helps you choose the right strategy. Many owners use the 1031 during their active investing and the 721 (often via the 1031-then-721 path) as their eventual exit into REIT ownership. Understanding when to use each lets you match the strategy to your goals and stage.
How Baker 1031 helps you choose
Baker 1031 Investments helps property owners choose between the 1031 and 721 exchanges — and use them together via the 1031-then-721 path — based on their goals. We help you weigh staying in direct real estate (1031, control and flexibility) against transitioning into REIT ownership (721, diversification, liquidity, passivity, estate planning), and we explain the one-way nature of the 721 so you choose with full understanding. For owners seeking the eventual REIT exit, we help structure the 1031-then-721 path through a DST.
REIT units, DST interests, and related securities are offered through the broker-dealer, Aurora Securities, Inc. (member FINRA/SIPC), and any recommendation follows a suitability review — the 721 exchange and the DST step of the 1031-then-721 path involve securities, available to suitable investors after a review. We coordinate with your CPA on the tax aspects of both strategies. Our role is to help you choose the right approach — 1031 for continued direct real estate, 721 for transitioning into REIT ownership, or the 1031-then-721 path for reaching REIT ownership through a DST — so you match the strategy to your goals and stage. Whether you want to keep exchanging real estate or transition into a REIT, we help you use the right tool.
Frequently Asked Questions
What's the difference between a 1031 and a 721 exchange?
A 1031 exchange trades like-kind real property for other real property, keeping you in direct real estate (with control and the ability to exchange again). A 721 exchange contributes your property to a REIT's operating partnership for OP units, moving you into REIT ownership (with diversification, liquidity, and passivity, but generally a one-way move — you can't 1031 out of OP units). Both defer the gain via carryover basis and offer the step-up at death, but they lead to fundamentally different outcomes: direct real estate versus REIT ownership.
Do both the 1031 and 721 defer taxes?
Yes — both defer capital gains tax via carryover basis, but under different code sections: the 1031 under Section 1031 (exchanging like-kind real property), the 721 under Section 721 (contributing property to a partnership for an interest). Both also offer the step-up in basis at death, which can erase the deferred gain. So both are tax-deferral (and potential tax-elimination, via the step-up) tools, differing in the transaction (like-kind exchange vs. partnership contribution) and the resulting holding (real property vs. OP units).
Which gives me more control?
The 1031 exchange — you own the replacement real property directly, retaining control over management, financing, and when to sell or exchange. The 721 exchange gives up control: you hold OP units in the REIT's operating partnership, with the REIT managing the properties; you're a passive unit holder. So if retaining control over your real estate matters, the 1031 keeps it, while the 721 trades it for the benefits of passive REIT ownership. The control difference is a key factor in choosing between them.
Which offers more liquidity and diversification?
The 721 exchange — OP units are convertible into REIT shares (liquid for public REITs, sellable in portions), and they represent a stake in the REIT's entire diversified portfolio (many properties, types, markets). The 1031 keeps you in direct real estate, which is illiquid and concentrated (though you can diversify across multiple replacements). So the 721 inherently provides liquidity and diversification that the 1031 doesn't, which is a key advantage of the 721 — at the cost of control and flexibility.
Can I do a 1031 exchange after a 721 exchange?
Generally no — once you hold OP units (from a 721 exchange), you can't do a 1031 exchange with them, because OP units are a partnership interest, not like-kind real property. Your options are to hold the units (deferred), convert them to REIT shares (taxable), or hold until death (step-up). So the 721 is generally a one-way move into REIT ownership — you can't reverse it via 1031 tax-free. This is why the 721 is an endpoint, a key consideration before doing one. The 1031, by contrast, keeps you able to exchange again.
When should I use a 1031 exchange?
When you want to stay in direct real estate — retaining control and the flexibility to keep exchanging, repositioning among properties, or building your portfolio. The 1031 fits owners who want to remain active or semi-active direct real estate investors, deferring tax while keeping their options open (able to exchange again). So use the 1031 for continued direct real estate ownership, when you value control and flexibility and want to keep trading real property. It's the choice for staying in direct real estate.
When should I use a 721 exchange?
When you want to transition into REIT ownership — gaining diversification, liquidity, and passivity, especially for estate planning — and you're ready to commit to that (accepting the one-way nature and loss of control). The 721 fits owners ready to exit direct real estate into a diversified, passive, more liquid REIT, as an endpoint. So use the 721 when transitioning out of direct real estate into REIT ownership is your goal, and you're prepared for the finality. It's the choice for the REIT exit.
What is the 1031-then-721 path?
A powerful combination: you do a 1031 exchange into a DST (deferring the gain, gaining passive real estate), and later, when the DST's property is acquired by a REIT via a 721 exchange (sometimes a planned 'UPREIT exit'), your DST interest is converted into OP units — transitioning from direct property, through a DST, into REIT ownership, all tax-deferred. This path combines the 1031 (into the DST) and the 721 (into the REIT), letting you reach diversified, liquid REIT ownership tax-deferred. It's a common modern strategy for eventually reaching REIT ownership.
Is the 721 better than the 1031?
Neither is universally better — they serve different goals. The 1031 is better for staying in direct real estate (control, flexibility, continued exchanging); the 721 is better for transitioning into REIT ownership (diversification, liquidity, passivity, estate planning, as an endpoint). The right choice depends on whether you want to remain a direct real estate owner or transition into a REIT. Many owners use the 1031 during active investing and the 721 (often via the 1031-then-721 path) as their eventual exit. Match the tool to your goals and stage.
Can I diversify with a 1031 exchange too?
Yes, to a degree — you can exchange into multiple replacement properties (or DSTs) in a 1031, diversifying across properties, types, and markets within direct real estate. So the 1031 allows diversification within real estate. But the 721 provides broader, instant diversification (a stake in the REIT's entire portfolio) and adds liquidity (convertible units) that the 1031 doesn't inherently offer. So both can diversify, but the 721 offers more comprehensive diversification plus liquidity, while the 1031's diversification stays within direct (illiquid) real estate ownership.
Does the step-up at death apply to both?
Yes — both the 1031 (replacement property) and the 721 (OP units) qualify for the step-up in basis at death, which can erase the deferred gain for your heirs. So both can ultimately eliminate the deferred gain if you hold the asset until death, making both powerful estate-planning tools. This shared step-up benefit means both strategies can permanently avoid the gain through the step-up. The estate-planning advantage applies whether you stay in direct real estate (1031) or transition into REIT units (721).
How do I decide between them?
Consider your goals: if you want to stay in direct real estate (control, flexibility, continued exchanging), choose the 1031; if you want to transition into REIT ownership (diversification, liquidity, passivity, estate planning, as an endpoint), choose the 721. Also consider your stage — many owners use the 1031 while actively investing and the 721 as their eventual exit. And consider the 1031-then-721 path for reaching REIT ownership through a DST. Weigh control/flexibility (1031) against diversification/liquidity (721), with your goals and advisors. We can help you decide.
Glossary
- 1031 Exchange
- Trading like-kind real property to defer gain, staying in direct real estate.
- 721 Exchange
- Contributing property to a REIT for OP units, moving into REIT ownership.
- Section 1031
- The like-kind exchange provision, for real-property-to-real-property trades.
- Section 721
- The partnership-contribution provision, for property-to-OP-units.
- Carryover Basis
- The basis-deferral mechanism shared by both exchanges.
- Step-Up in Basis
- The death-time reset, available for both replacement property and OP units.
- Control
- Direct-ownership decision-making, retained with 1031, given up with 721.
- Flexibility
- The ability to exchange again, retained with 1031, lost with 721.
- Liquidity
- Convertibility to tradable shares, offered by the 721, not inherently the 1031.
- Diversification
- Exposure to a portfolio, broad with the 721's REIT units.
- One-Way Move
- The 721's generally irreversible nature (can't 1031 out).
- OP Units
- The partnership interest from a 721, not eligible for a 1031.
- 1031-then-721 Path
- Exchanging into a DST, later UPREIT'd into a REIT via a 721.
- Delaware Statutory Trust (DST)
- A passive 1031 vehicle, often the step toward a 721 REIT exit.
- UPREIT Exit
- A REIT acquiring a property/DST via a 721 exchange.
- Endpoint
- The 721 as a final transition into REIT ownership.
Sources & References
- Cornell Legal Information Institute. 26 U.S. Code § 1031
- Cornell Legal Information Institute. 26 U.S. Code § 721 — Nonrecognition of gain or loss on contribution
- U.S. Securities and Exchange Commission. Investor.gov — Real Estate Investment Trusts (REITs)
- IRS. Like-Kind Exchanges Under IRC Section 1031 (FS-2008-18)
Disclosures
This article is published by Baker 1031 Investments, LLC for general educational purposes for accredited investors and is not an offer to sell or a solicitation of an offer to buy any security, nor is it tax, legal, accounting, or investment advice or a recommendation. Any securities offering is made solely through a sponsor’s private placement memorandum (PPM) following a suitability determination. Securities offered through Aurora Securities, Inc. (ASI), member FINRA / SIPC; Baker 1031 Investments is independent of ASI.
Oil & gas mineral and royalty interests and DST programs are speculative, illiquid securities sold only to verified accredited investors and involve substantial risk, including possible loss of principal, commodity-price and production-decline risk, lack of control, and the risk that an intended 1031 exchange fails to qualify for tax deferral. Whether a particular interest qualifies as like-kind real property is a fact-specific legal determination that varies by state and by the terms of the instrument. Tax results depend on your individual circumstances. Consult your own CPA and attorney before acting. Past performance does not guarantee future results.
