One of the most powerful modern real estate strategies combines two tax-deferral provisions — Section 1031 and Section 721 — into a two-step path from direct property to REIT ownership. Here's how it works: first, an investor sells their property and does a 1031 exchange into a Delaware Statutory Trust (DST), deferring the gain and gaining passive, fractional real estate. Then, later, the REIT sponsoring or affiliated with the DST acquires the DST's property through a 721 exchange, converting the investor's DST interest into operating partnership units in the REIT. The result: the investor has transitioned from a single property, through a DST, into diversified, liquid REIT ownership — all tax-deferred across both steps. This 'DST-to-REIT' or '1031-then-721' strategy is increasingly popular. This guide explains the two steps, why combine them, what to confirm, and the tax treatment.
The two-step strategy overview
The DST-to-REIT strategy combines two tax-deferred steps into a path from direct property to REIT ownership. Step one is a 1031 exchange into a DST: the investor sells their property and exchanges into a Delaware Statutory Trust, deferring the gain under Section 1031 and gaining a passive, fractional interest in the DST's real estate. Step two is a 721 exchange into a REIT: later, the REIT acquires the DST's property (or the DST is otherwise UPREIT'd), and the investor's DST interest is converted into operating partnership (OP) units in the REIT, under Section 721.
The combination achieves what neither step alone fully does. The 1031 into the DST gets the investor into passive real estate tax-deferred, but a DST is a single offering (often a single property or small portfolio) and is illiquid. The 721 into the REIT then transitions the investor into the REIT's broad, diversified portfolio with the liquidity of convertible REIT units. So the two steps together take the investor from direct property to diversified, liquid REIT ownership, all tax-deferred.
This two-step path is increasingly common because it solves a sequencing problem: you can't directly 721 your individual property into most REITs easily (the REIT must want your specific property), but you can 1031 into a DST, and DSTs are often structured to be acquired by a REIT (the 721 exit). So the DST is the intermediary that bridges your property to the REIT. The two-step strategy overview — a 1031 into a DST (step one) followed by a 721 into a REIT (step two), reaching diversified, liquid REIT ownership tax-deferred — is the framework of the DST-to-REIT strategy. The two steps together achieve a transition that uses the DST as a bridge from direct property to REIT ownership. Understanding the overview sets up the details of each step and why the combination is powerful.
Step one: 1031 into a DST
Step one is a standard 1031 exchange into a Delaware Statutory Trust. The investor sells their relinquished property and, within the 1031 deadlines (45-day identification, 180-day completion), exchanges into a DST — a pre-packaged, securitized real estate investment offering fractional ownership of institutional-quality property. This defers the gain under Section 1031 and transitions the investor from direct property into passive, fractional DST ownership.
The DST step provides immediate benefits: tax deferral (Section 1031), passive ownership (the DST sponsor manages the property), and access to institutional-quality real estate. The investor goes from managing their own property to holding a passive DST interest, earning distributions, with the gain deferred. For many investors, the DST step alone is a satisfying outcome — passive, tax-deferred real estate. But for those who want to eventually reach REIT ownership, the DST step is also the setup for step two.
Crucially, for the two-step strategy, the DST must be structured with a potential 721/UPREIT exit — meaning the REIT affiliated with the DST intends (or has the option) to later acquire the DST's property and convert the investors' interests into OP units. Not every DST has this feature, so investors pursuing the two-step strategy choose a DST structured for the 721 exit. Step one — a 1031 exchange into a DST (deferring the gain, gaining passive real estate) — is the first step of the DST-to-REIT strategy, transitioning the investor from direct property into a passive DST interest tax-deferred. Choosing a DST structured for a 721/UPREIT exit sets up step two. Understanding step one shows how the investor first moves into passive real estate (the DST) before the later transition to the REIT. The DST step is the foundation that the 721 exit builds upon.
Step one is a standard 1031 into a DST — but for the two-step strategy, the DST must be structured with a potential 721/UPREIT exit, so the REIT can later acquire it and convert your interest into OP units.
Step two: the DST's 721/UPREIT exit
Step two is the 721/UPREIT exit, where the investor's DST interest converts into REIT operating partnership units. At some point after the DST investment (the timing depends on the DST and REIT), the REIT acquires the DST's property — and rather than the investors receiving cash (which would trigger their deferred gain), their DST interests are converted into OP units in the REIT's operating partnership, under Section 721. This defers the gain again (now under Section 721), transitioning the investor from the DST into the REIT.
After step two, the investor holds OP units in the REIT — a stake in the REIT's entire diversified portfolio, with the benefits of REIT ownership (diversification, liquidity via convertible units, passive income, estate planning). So the investor has moved from the single DST (one property or small portfolio) into the broad REIT portfolio, gaining diversification and the path to liquidity that the DST didn't offer. The 721 exit is what transitions the investor into the full REIT.
The timing of step two isn't always certain — it depends on when (or whether) the REIT acquires the DST's property, which is governed by the DST/REIT structure and the sponsor's plans. Some DSTs have a planned exit timeline; others have the option but not a fixed date. So investors should understand the expected (but not always guaranteed) timing of the 721 exit. Step two — the DST's 721/UPREIT exit, converting the investor's DST interest into REIT OP units under Section 721 — is the second step that transitions the investor from the DST into the diversified, liquid REIT. This step delivers the REIT ownership benefits (diversification, liquidity) the DST alone didn't. Understanding step two shows how the investor completes the journey into REIT ownership, tax-deferred, via the 721 exit. The 721 exit is the culmination of the two-step strategy.
Why combine the two
Combining the 1031 and 721 into this two-step strategy offers advantages neither step alone provides. The 1031 into a DST gets you into passive, tax-deferred real estate, but a DST is a single, illiquid offering. The 721 into a REIT gives diversification and liquidity, but you generally can't 721 your individual property directly into most REITs (they must want your specific property). Combining them — 1031 into a DST, then 721 into the REIT — bridges your individual property to the diversified, liquid REIT, using the DST as the intermediary.
The combination thus achieves the full transition: from your concentrated, illiquid, management-intensive single property, to a diversified, liquid, passive REIT, all tax-deferred. You get the DST's benefits first (passive, tax-deferred real estate) and then the REIT's benefits (diversification, liquidity, the path to the broad portfolio and eventual share liquidity). Neither step alone reaches this endpoint as smoothly; together they do.
The combination also offers flexibility and a staged transition. You first move into the DST (a defined, passive investment), and then transition into the REIT (broader, more liquid) — a staged path that some investors find more comfortable than a direct leap. And throughout, the deferral is preserved (Section 1031 then Section 721), with the eventual step-up at death available on the OP units. Why combine the two — to bridge your individual property to a diversified, liquid REIT (which you generally can't reach directly), achieving the full transition tax-deferred via the DST intermediary — is the rationale for the two-step strategy. The combination reaches an endpoint (diversified, liquid REIT ownership) that neither step alone achieves as smoothly. Understanding why to combine them shows the strategic value of the DST-to-REIT path for investors wanting to ultimately reach REIT ownership from direct property. The combination is what makes the full transition possible and tax-deferred.
What to confirm before investing
Because the two-step strategy depends on the 721 exit materializing, there are important things to confirm before investing in the DST. Most important: confirm the DST is actually structured with a 721/UPREIT exit — that the REIT intends or has the option to acquire the DST's property and convert investors' interests into OP units. Without this structure, the DST won't lead to the REIT, and the two-step strategy won't work. So verify the 721-exit structure before investing.
Also understand the expected timing and certainty of the 721 exit — is there a planned timeline, or just an option? How certain is the exit? Because the timing may not be guaranteed, understand what you're relying on. Evaluate the REIT itself (since you'll end up owning it) — its portfolio, quality, management, track record, and (for the eventual share liquidity) whether it's traded or non-traded. You're ultimately investing in the REIT, so its quality matters.
Also understand the tax implications (the deferral across both steps, the eventual tax on converting OP units to shares), the fees and structure, and the trade-offs (the one-way nature of the eventual REIT ownership, the loss of control). These are securities, so a suitability review applies. What to confirm before investing — that the DST is structured for a 721/UPREIT exit, the expected timing and certainty of the exit, the quality of the REIT you'll end up owning, and the tax implications and trade-offs — is essential due diligence for the two-step strategy. Because the strategy depends on the 721 exit and lands you in the REIT, confirming these factors protects you. Understanding what to confirm ensures you enter the two-step strategy with clear expectations and a sound DST and REIT. This due diligence is critical before committing to the DST-to-REIT path.
- The DST-to-REIT strategy: a 1031 into a DST (step one), then a 721 into a REIT (step two), reaching diversified, liquid REIT ownership tax-deferred.
- The DST is the bridge — you generally can't 721 your individual property directly into a REIT, but a DST can be structured for a 721/UPREIT exit.
- Confirm before investing: that the DST is structured for a 721 exit, the expected timing/certainty, and the quality of the REIT you'll end up owning.
- The deferral is preserved across both steps (Section 1031 then Section 721), with the step-up available on the eventual OP units.
Tax treatment across both steps
Understanding the tax treatment across both steps clarifies how the deferral is preserved throughout. Step one (the 1031 into the DST) defers the gain under Section 1031 — the gain carries over into the DST interest's basis. Step two (the 721 into the REIT) defers the gain again under Section 721 — the gain carries over into the OP units' basis. So the deferral is continuous across both steps: the original gain (and any appreciation) remains deferred, carried from the property, through the DST, into the OP units.
The deferral continues as you hold the OP units, and is triggered only when you eventually convert the units to REIT shares or cash (a taxable event) — or never, if you hold until death (when the step-up can erase the gain). So the two-step strategy preserves the deferral all the way through to the OP units, with the eventual tax triggered only on your conversion (or eliminated by the step-up). This continuous deferral across both steps is the strategy's tax power.
The detailed tax mechanics (the basis carrying through both steps, the built-in gain, any tax protection on the 721 exit) are technical and handled by your CPA. The key point is that both steps are tax-deferred, preserving the gain continuously from property to OP units. Tax treatment across both steps — Section 1031 deferring the gain into the DST interest, then Section 721 deferring it into the OP units, with continuous deferral until you convert (or the step-up erases it) — shows how the two-step strategy preserves the deferral throughout. The gain carries from property, through the DST, into the OP units, deferred all the way. Understanding the tax treatment confirms that the two-step strategy is fully tax-deferred across both steps, which is its central appeal. The continuous deferral, with the eventual step-up, makes the DST-to-REIT strategy a powerful tax-deferral and estate-planning path.
How Baker 1031 helps with the two-step strategy
Baker 1031 Investments helps investors execute the DST-to-REIT two-step strategy — guiding the 1031 exchange into a DST structured for a 721/UPREIT exit (confirming the exit structure, timing, and the quality of the eventual REIT), and coordinating the later 721 exit into the REIT. We help you understand and navigate both steps, with the due diligence to ensure the DST and REIT are sound and the strategy fits your goals.
DST interests, REIT units, and related securities are offered through the broker-dealer, Aurora Securities, Inc. (member FINRA/SIPC), and any recommendation follows a suitability review — both steps involve securities, available to suitable, typically accredited investors after a review. We coordinate with your CPA on the tax treatment across both steps (the continuous deferral, the basis, the eventual conversion, the step-up). Our role is to help you use the DST-to-REIT strategy to transition from direct property, through a DST, into diversified, liquid REIT ownership — all tax-deferred — with the due diligence and coordination the two-step strategy requires. For investors wanting to ultimately reach REIT ownership tax-deferred, we help navigate this powerful two-step path soundly.
Frequently Asked Questions
What is the DST-to-REIT strategy?
A two-step path combining a 1031 exchange into a Delaware Statutory Trust (step one, deferring the gain under Section 1031) with a later 721 exchange into a REIT (step two, when the REIT acquires the DST's property and converts your interest into OP units under Section 721). It transitions you from direct property, through a DST, into diversified, liquid REIT ownership — all tax-deferred. The DST is the bridge, since you generally can't 721 your individual property directly into most REITs. It's increasingly popular for reaching REIT ownership tax-deferred.
Why use two steps instead of going directly into a REIT?
Because you generally can't 721 your individual property directly into most REITs — the REIT must want your specific property, which is uncommon for a typical individual property. But you can 1031 into a DST, and DSTs are often structured to be acquired by a REIT (the 721 exit). So the DST is the intermediary that bridges your property to the REIT. The two-step path makes the transition possible when a direct 721 of your property isn't feasible. The DST solves the sequencing problem of reaching the REIT.
What happens in step one?
A standard 1031 exchange into a DST: you sell your relinquished property and, within the 1031 deadlines (45/180 days), exchange into a Delaware Statutory Trust — deferring the gain under Section 1031 and gaining a passive, fractional interest in institutional-quality real estate. You transition from managing your own property to holding a passive DST interest, earning distributions, with the gain deferred. For the two-step strategy, the DST must be structured with a potential 721/UPREIT exit, setting up step two.
What happens in step two?
The 721/UPREIT exit: at some point after your DST investment, the REIT acquires the DST's property, and rather than receiving cash (which would trigger your gain), your DST interest is converted into OP units in the REIT's operating partnership under Section 721 — deferring the gain again. You transition from the single DST into the REIT's broad, diversified portfolio, gaining diversification and the path to liquidity (convertible units) the DST didn't offer. Step two completes your journey into REIT ownership, tax-deferred.
Is the whole strategy tax-deferred?
Yes — the deferral is continuous across both steps. Step one defers the gain under Section 1031 (carried into the DST interest's basis); step two defers it under Section 721 (carried into the OP units' basis). The gain remains deferred from your property, through the DST, into the OP units. It's triggered only when you eventually convert the OP units to REIT shares/cash (a taxable event) — or never, if you hold until death (the step-up erasing it). So both steps are tax-deferred, preserving the gain continuously.
What should I confirm before investing in the DST?
Most importantly, that the DST is actually structured with a 721/UPREIT exit (the REIT intends or has the option to acquire it and convert interests into OP units) — without this, the two-step strategy won't work. Also confirm the expected timing and certainty of the exit (planned timeline or just an option?), the quality of the REIT you'll end up owning (portfolio, management, traded or non-traded), and the tax implications, fees, and trade-offs. This due diligence ensures the strategy will work and the DST and REIT are sound.
Is the 721 exit guaranteed?
Not always — the timing and certainty depend on the DST/REIT structure and the sponsor's plans. Some DSTs have a planned exit timeline; others have the option but not a fixed date or guarantee. So the 721 exit may be expected but not guaranteed. Understand what you're relying on before investing — whether there's a planned exit or just an option, and how certain it is. Because the strategy depends on the exit materializing, confirming its expected timing and certainty is important due diligence. Don't assume the exit is guaranteed without confirming.
What REIT will I end up owning?
The REIT affiliated with or acquiring the DST — so you should evaluate that REIT before investing in the DST, since you'll ultimately own it. Consider its portfolio (quality, diversification, property types), management and track record, and whether it's publicly traded (offering share liquidity) or non-traded (more limited liquidity). You're effectively investing in this REIT's future, so its quality matters greatly. Understanding which REIT you'll end up owning, and evaluating it, is a key part of the due diligence for the two-step strategy.
When does the 721 exit happen?
The timing depends on the DST and REIT — some have a planned timeline (e.g., a target number of years), others have the option to exit when the sponsor decides. So the exit could happen after a few years or on a less defined schedule. The timing isn't always fixed or guaranteed. Understand the expected timing before investing, recognizing it may not be precise. The 721 exit happens when the REIT acquires the DST's property, which the DST/REIT structure governs. Confirm the expected timing as part of your due diligence.
What are the trade-offs of the two-step strategy?
The eventual REIT ownership is generally a one-way move (you can't 1031 out of OP units), so you commit to REIT ownership as the endpoint. You also give up control (the DST sponsor, then the REIT, manage the properties), depend on the DST and REIT, face the eventual tax on converting OP units to shares, and rely on the 721 exit materializing (timing not always guaranteed). These trade-offs accompany the benefits (deferral, diversification, liquidity, passivity, estate planning). Weigh them with your goals and advisors before committing.
Who is the two-step strategy best for?
Investors who want to ultimately reach diversified, liquid REIT ownership from direct property, tax-deferred — especially those ready to exit active management into passive ownership, seeking diversification and eventual liquidity, and focused on estate planning (the step-up on the eventual OP units). It suits accredited investors comfortable with the securities nature, the trade-offs (one-way, loss of control), and the reliance on the 721 exit. For investors wanting the full transition from property to REIT tax-deferred, the two-step strategy is a powerful path.
Are both steps securities transactions?
Yes — both the DST interest (step one) and the REIT OP units (step two) are securities, so the two-step strategy involves securities throughout, offered through a broker-dealer to suitable (typically accredited) investors after a suitability review. This means securities regulation applies, and a financial professional assesses whether the strategy fits your circumstances. The securities nature is important to understand — both steps require working with a securities-licensed advisor, and the investments carry the considerations (suitability, accreditation, risk disclosure) of securities. Professional guidance is essential.
Glossary
- DST-to-REIT Strategy
- The two-step path: 1031 into a DST, then 721 into a REIT.
- Two-Step Strategy
- Combining a 1031 (into a DST) and a 721 (into a REIT).
- 1031-then-721
- Another name for the DST-to-REIT two-step strategy.
- Delaware Statutory Trust (DST)
- The passive 1031 vehicle that bridges to the REIT.
- 721/UPREIT Exit
- The REIT acquiring the DST and converting interests to OP units.
- Step One
- The 1031 exchange into a DST, deferring under Section 1031.
- Step Two
- The 721 exchange into the REIT, deferring under Section 721.
- OP Units
- The REIT operating partnership units received in step two.
- Continuous Deferral
- The gain deferred across both steps, property to OP units.
- Section 1031
- The provision deferring gain in step one (into the DST).
- Section 721
- The provision deferring gain in step two (into the REIT).
- Bridge
- The DST's role connecting your property to the REIT.
- Exit Timing
- When the 721 exit occurs, not always fixed or guaranteed.
- Traded vs Non-Traded REIT
- Whether the eventual REIT's shares are exchange-listed (liquidity).
- Step-Up in Basis
- The death-time reset available on the eventual OP units.
- Accredited Investor
- The investor status typically required for these securities.
Sources & References
- Cornell Legal Information Institute. 26 U.S. Code § 721 — Nonrecognition of gain or loss on contribution
- Cornell Legal Information Institute. 26 U.S. Code § 1031
- IRS. Revenue Ruling 2004-86 (Delaware Statutory Trusts)
- U.S. Securities and Exchange Commission. Investor.gov — Real Estate Investment Trusts (REITs)
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.
