A 721 exchange — named for Section 721 of the tax code — lets you contribute real estate into a REIT's operating partnership in return for "OP units," deferring your gain just as a 1031 does. For DST investors, it's the most common way to graduate from a single trust into a diversified, institutional REIT. But unlike a 1031, it's a one-way door: once you hold OP units, you can't 1031 again.
This guide is the companion to our DST guide, where the 721 appears as an exit strategy. This guide covers the two-step path, the benefits, the trade-offs, and an interactive tool that shows your tax under each way you might eventually exit.
- A 721 exchange swaps real estate (often a DST) for OP units in a REIT's operating partnership — tax-deferred under Section 721.
- It's typically a two-step path for 1031 investors: 1031 into a DST, then the REIT acquires the DST and you receive OP units.
- It's a one-way move: OP units can't be 1031'd, the gain is deferred (not erased), and converting OP units to REIT shares is taxable — but heirs still get a step-up at death.
01 · What a 721 Exchange (UPREIT) Is
"UPREIT" stands for Umbrella Partnership REIT — the structure where a REIT holds its properties through an operating partnership (the "OP"). Section 721 says that contributing property to a partnership in exchange for a partnership interest isn't a taxable event. So when you contribute real estate (or a DST interest the REIT acquires) into the OP, you receive operating partnership units instead of cash, and your built-in gain rides along, deferred. Those OP units economically mirror REIT shares — they pay the same distributions and track the same value — and can typically be converted to actual REIT shares later, on your timetable.
02 · The Two-Step DST Path
You generally can't 1031 directly into OP units — OP units aren't eligible 1031 replacement property. So 1031 investors take a two-step route. Click through it:
03 · The Benefits
- Continued tax deferral. Section 721 defers your gain when you receive OP units — the 1031 deferral keeps rolling.
- Real diversification. You move from one DST property into a large REIT portfolio across many assets and markets.
- Professional management and institutional scale, fully passive.
- A path to liquidity. Converting OP units to publicly traded REIT shares gives you liquidity that raw real estate and DSTs lack — you can sell shares piecemeal.
- Estate planning. OP units are easy to divide among heirs, who receive a step-up in basis at death that can erase the deferred gain.
04 · The Trade-offs
- It's one-way. Once you hold OP units, you can't do another 1031 exchange — OP units aren't like-kind replacement property. A DST, by contrast, lets you (or your heirs) keep exchanging.
- Deferred, not eliminated. The built-in gain carries into your OP units and comes due when you finally sell.
- Conversion is taxable. Converting OP units into REIT shares is a taxable event that triggers the deferred gain — though you can often convert incrementally to spread the tax.
- Timing & control. Most conversions are optional after a holding period, but some DST-to-721 structures are designed for a mandatory conversion — read the specific deal.
- Distributions are REIT income. Your distributions are taxed as REIT dividends, not the partly sheltered cash flow a depreciating DST can provide.
05 · OP Units vs. REIT Shares vs. DST
| Feature | DST interest | OP units (721) | REIT shares |
|---|---|---|---|
| Tax deferral | Yes, until exit | Yes, while held | No — taxable on sale |
| Future 1031 eligible | Yes | No | No |
| Liquidity | Low (5–10 yr) | Low–moderate | High (if traded) |
| Step-up at death | Yes | Yes | Yes |
| Income type | DST distributions | OP distributions | REIT dividends |
General comparison; specific terms vary by sponsor and REIT. Converting OP units to REIT shares is a taxable event.
06 · Should You Take the 721?
The decision usually comes down to one question: are you done exchanging? If you want to keep the 1031 option alive, a DST preserves it; if you're ready to settle into a diversified REIT for income and eventual liquidity, the 721 delivers. Answer four questions:
07 · What Happens to Your Tax
The whole 721 calculus turns on how you eventually exit. Hold your OP units and you keep deferring; convert to REIT shares and sell and you pay; hold until death and your heirs may pay nothing. Enter your deferred gain to see all three:
Illustrative only. "Convert & sell" recognizes the deferred gain (appreciation after the 721 adds to it); distributions are taxed separately as REIT dividends; the step-up assumes current law. Not tax advice — confirm with your CPA.
08 · Are You Ready? Mandatory vs. Optional
Before you commit, make sure you understand what you're signing up for — especially whether your DST's conversion to OP units is optional or mandatory. Confirm each point:
Check each statement you understand and agree with. The first three are non-negotiable.
09 · The Process & Timeline
- 1031 into a DST that's structured with a future 721/UPREIT option (often called an "UPREIT-eligible" DST).
- Hold the DST and receive distributions while the sponsor executes the business plan.
- The REIT's operating partnership acquires the DST — timing set by the sponsor/REIT, not you.
- You receive OP units under Section 721 — gain still deferred.
- Hold, convert, or pass on. Keep the units for income, convert to REIT shares (taxable) for liquidity, or hold until death for the step-up.
10 · Taxes & Estate Planning
Holding OP units defers your gain indefinitely; the distributions you receive are taxed as REIT dividends. The tax moment that matters is conversion: turning OP units into REIT shares is a recognition event, so plan it deliberately — converting in tranches across several years can keep you in lower brackets. The most tax-efficient outcome is often to never convert during life: hold the OP units, collect income, and let your heirs inherit them with a stepped-up basis that wipes out the deferred gain. The trade-off versus a DST is that your heirs can't keep 1031-ing — but they also don't have to manage a rolling exchange strategy.
11 · Risks & Due Diligence
You're underwriting a REIT, not a single building — so evaluate the REIT's portfolio quality, leverage, distribution coverage and history, management, and whether its shares are publicly traded or non-traded (which determines your real liquidity). On the structure itself, read whether the 721 conversion is optional or mandatory and what holding period applies, and model the tax of an eventual conversion before you assume "tax-free." As always, a zero-tax move into an underperforming REIT is still a poor investment.
12 · Frequently Asked Questions
Can I 1031 exchange out of OP units later?
No. Operating partnership units are not eligible 1031 replacement property, so a 721 is effectively a one-way move. This is the central trade-off versus staying in a DST, which preserves the 1031 option for you and your heirs.
Is converting OP units to REIT shares taxable?
Yes. Converting OP units into REIT shares (or redeeming them for cash) is a taxable event that triggers the deferred gain. Many investors convert incrementally over several years to manage the tax.
Does the 721 eliminate my tax?
No — it defers it. The built-in gain carries into your OP units and is recognized when you sell or convert. The only way it disappears is the step-up in basis your heirs receive at death.
Do I have to convert, or can I just hold?
Usually you can hold OP units indefinitely and collect distributions. But check your specific deal — some DST-to-721 structures are designed for a mandatory conversion, which removes your control over the timing of the tax.
How is this different from staying in a DST?
A DST keeps your 1031 options open — at full cycle you can exchange into another DST or property. A 721 trades that flexibility for diversification into a REIT, professional management, and a path to liquidity, at the cost of never 1031-ing again. See our DST guide for that path.
13 · Glossary
- 721 Exchange
- Contributing property to a REIT's operating partnership for OP units, tax-deferred under IRC Section 721.
- UPREIT
- Umbrella Partnership REIT — a REIT that holds property through an operating partnership.
- Operating Partnership (OP) Units
- Partnership interests that mirror REIT shares in value and distributions; convertible to shares later.
- UPREIT-Eligible DST
- A DST structured so the REIT can later acquire it and issue OP units to investors.
- Conversion
- Exchanging OP units for REIT shares — a taxable event that recognizes the deferred gain.
- Mandatory vs. Optional
- Whether the DST-to-OP-units conversion is forced on a schedule or left to the investor's choice.
- Step-Up in Basis
- The reset of basis to fair-market value at death, which can erase the deferred gain for heirs.
14 · Disclosures
This material is for educational and informational purposes only and does not constitute investment, legal, tax, or financial advice, nor an offer or solicitation with respect to any security or property. 721 exchanges, DSTs, and REIT investments are complex, illiquid, generally limited to accredited investors, and may lose value, including loss of principal.
Whether a DST offers a 721/UPREIT option, whether conversion is mandatory or optional, and the tax consequences of receiving and later converting OP units depend on the specific offering documents and your circumstances. Converting OP units to REIT shares is generally a taxable event. Calculator outputs are simplified estimates under current law and may change. Consult a qualified intermediary, CPA, and attorney before acting.
