For real estate owners focused on passing wealth to the next generation, the 721 exchange offers a remarkable estate-planning advantage. By converting your property into operating partnership units and holding those units until death, you can combine lifetime tax deferral with the step-up in basis at death — potentially erasing the entire deferred gain for your heirs. Your heirs inherit the units with a basis stepped up to fair market value, so they can convert them to REIT shares or receive cash with little or no income tax on the prior appreciation. On top of this, the units divide cleanly among multiple heirs (unlike a single property, which is hard to split). This combination makes the 721 exchange a sophisticated wealth-transfer tool. This guide explains the estate-planning power of the 721, how the step-up works, the deferral-plus-step-up combination, divisibility, and coordinating with your estate plan.
The estate-planning power of the 721
The 721 exchange's estate-planning power comes from combining two tax advantages: lifetime deferral and the step-up at death. During your life, the 721 exchange defers the capital gains tax on your property (under Section 721), so you don't pay tax on the appreciation while you hold the OP units. At death, the step-up in basis can erase that deferred gain (and any further appreciation) for your heirs. Together, these mean the gain can be deferred during life and eliminated at death.
This is the same powerful combination that makes the 1031 exchange a wealth-transfer tool ('swap till you drop'), applied through the 721 into REIT ownership. The 721 lets you achieve this combination while gaining the benefits of REIT ownership (diversification, liquidity, passivity) — which a 1031 (keeping you in direct real estate) doesn't offer. So the 721 brings the deferral-plus-step-up power into a diversified, passive, more liquid form.
For an estate-focused owner, this power is compelling: you can exit your concentrated, management-intensive property into a diversified, passive REIT holding, defer the gain during life, earn income from the units, and pass them to heirs with the gain erased. The 721 exchange thus serves estate planning and lifetime goals together. The estate-planning power of the 721 — combining lifetime deferral (Section 721) with the step-up at death (erasing the gain for heirs), while gaining REIT ownership's benefits — makes it a sophisticated wealth-transfer tool. This combination, applied through a diversified, passive REIT holding, is the 721 exchange's estate-planning appeal. Understanding this power sets up the details of how the step-up works and how to use the 721 for estate planning. The deferral-plus-step-up combination is the heart of the 721's estate-planning value.
How the step-up works on OP units
The step-up in basis works on OP units as it does on other inherited assets. When you die holding OP units, your heirs inherit them with a basis 'stepped up' to the fair market value as of your death (under the general step-up rule for inherited property). This means the heirs' basis becomes the current value, not your old (carried-over, low) basis — erasing the difference, which is the deferred gain.
Concretely: suppose you contributed property with a $1,000,000 deferred gain, so your OP units carry that embedded gain (low basis). If you held the units until death and they're worth, say, $3,000,000 then, your heirs inherit them with a basis of $3,000,000 (the stepped-up value). The deferred $1,000,000 gain (and any further appreciation) is erased — your heirs can convert the units to shares or receive cash based on the $3,000,000 basis, with little or no income tax on the prior gain.
This step-up is why holding the OP units until death is so powerful — it eliminates the deferred gain that would otherwise be triggered if you converted or sold during life. The heirs effectively receive the units free of the embedded income tax. (Estate tax is a separate consideration, depending on the estate's size and the estate-tax rules, which your estate attorney addresses.) How the step-up works on OP units — heirs inheriting them with a basis stepped up to fair market value at death, erasing the deferred gain — is the mechanism behind the 721's estate-planning power. The step-up eliminates the embedded income tax for heirs, who receive the units at the current value. Understanding how the step-up works shows why holding the units until death is the key to the estate strategy. The step-up is the mechanism that turns deferral into elimination of the gain for the next generation.
Hold OP units until death and your heirs inherit them at the stepped-up, current value — erasing the deferred gain, so they can convert or sell with little or no income tax on the prior appreciation.
Deferral during life + step-up at death
The full estate strategy combines deferral during life with the step-up at death, which work together over your lifetime and beyond. During your life, you hold the OP units, deferring the gain (no tax on the appreciation) and earning distributions (income from the REIT's portfolio). You enjoy the income and the deferral, with the gain growing (as the units appreciate) but untaxed. This is the lifetime phase — income and deferral.
At death, the step-up takes over — your heirs inherit the units with a stepped-up basis, erasing the accumulated deferred gain. So the gain you deferred during life (plus appreciation) is eliminated at death, never taxed (for income-tax purposes). The lifetime deferral preserved the gain (untaxed) until death, when the step-up erased it. The two phases — lifetime deferral and death-time step-up — combine to defer then eliminate the gain.
This combination is more powerful than either alone. Deferral alone (without the step-up) would eventually be taxed when you converted or sold; the step-up alone (without deferral) wouldn't apply if you'd already triggered the gain. Together, the deferral keeps the gain untaxed until death, and the step-up then erases it — eliminating the gain entirely. Deferral during life plus the step-up at death — holding the OP units to defer the gain and earn income during life, then passing them to heirs with the step-up erasing the gain — is the combination that makes the 721 exchange a powerful estate tool. The two phases work together: deferral preserves the gain untaxed until death, and the step-up eliminates it. Understanding this combination shows the full estate strategy: hold the units for life (income, deferral), pass them at death (step-up). This is how the 721 exchange transfers real estate wealth tax-efficiently across generations.
Divisibility among heirs
Beyond the step-up, the divisibility of OP units offers a major practical estate-planning advantage. A single property is difficult to divide among multiple heirs — you can't easily split a building three or four ways, which often forces a sale (to divide the proceeds) or creates shared ownership (with the attendant disputes and management complications). This makes a single property an awkward asset to pass to multiple heirs.
OP units, by contrast, are easily divisible — you can bequeath specific numbers of units to each heir, cleanly dividing your real estate wealth without forcing a sale or creating shared-property complications. Each heir receives their units (with the stepped-up basis) and can independently decide to hold them (for income), convert to shares, or sell — without being entangled with the other heirs in a shared property. So the units divide cleanly, giving each heir their own portion to manage independently.
This divisibility solves a common estate problem: how to fairly and cleanly divide real estate among multiple heirs. By converting the property into divisible units (via the 721 exchange), you transform an indivisible asset into an easily-divided one, simplifying your estate. Divisibility among heirs — the ease of dividing OP units among multiple heirs (each receiving their units with the stepped-up basis to manage independently), versus the difficulty of dividing a single property — is a major practical estate advantage of the 721 exchange. It solves the problem of fairly dividing real estate among heirs, transforming an indivisible property into divisible units. Understanding the divisibility benefit shows that the 721 exchange aids estate planning not just through the step-up (erasing the gain) but through the practical ease of dividing the inheritance. The divisibility complements the step-up in making the 721 exchange an excellent estate-planning tool.
Comparing to holding the original property
It's worth comparing the 721 estate strategy to simply holding your original property until death (which also gets a step-up), to see the 721's added value. Holding your original property until death does get a step-up (erasing the gain on that property), so the step-up benefit alone isn't unique to the 721 — direct real estate held until death also gets it. So why use a 721 exchange for estate planning if holding the property also gets the step-up?
The 721's added value is in the other benefits it brings while still getting the step-up. By doing a 721 exchange, you gain diversification (the REIT portfolio vs. your single property), liquidity (convertible units vs. illiquid property), passivity (no management vs. managing the property), and divisibility (easy division among heirs vs. an indivisible property) — all while still getting the step-up at death. So the 721 gives you the step-up plus these additional benefits, which holding the original property doesn't.
So the comparison favors the 721 for owners who want diversification, liquidity, passivity, and divisibility in addition to the step-up. If you'd be content holding your single, illiquid, management-intensive property until death (just for the step-up), you could — but the 721 lets you get the step-up while also diversifying, gaining liquidity, shedding management, and easing the division among heirs. Comparing to holding the original property — both get the step-up, but the 721 adds diversification, liquidity, passivity, and divisibility — shows the 721's added estate-planning value. The 721 gives the step-up plus these benefits, which simply holding the property doesn't. Understanding this comparison clarifies why an estate-focused owner might prefer the 721 over holding their property: the same step-up, but with diversification, liquidity, passivity, and easy division. The 721 enhances the estate strategy beyond what holding the original property offers.
- The 721 exchange combines lifetime deferral with the step-up at death — potentially erasing the deferred gain entirely for heirs.
- Heirs inherit OP units with a basis stepped up to fair market value, eliminating the embedded income tax on the prior gain.
- OP units divide cleanly among multiple heirs (each managing their own units), unlike an indivisible single property.
- Both the 721 and holding the original property get the step-up — but the 721 adds diversification, liquidity, passivity, and divisibility.
Coordinating with your estate plan
Using the 721 exchange for estate planning requires coordinating with your broader estate plan and professionals. The income-tax benefits (deferral and step-up) are one piece, but your estate plan also involves estate tax (a separate tax on the estate's value, depending on its size and the estate-tax exemption and rules), the structure of your bequests (how the units pass to heirs — outright, in trust, etc.), and your overall wealth-transfer goals. So the 721 exchange should fit within your comprehensive estate plan, coordinated with your estate attorney.
Estate-tax considerations matter because the step-up addresses income tax (the deferred gain), not estate tax. Depending on your estate's size, estate tax may apply to the value of the units (as to other assets), which your estate attorney plans for (using exemptions, trusts, gifting strategies, etc.). So the 721's income-tax benefits (deferral, step-up) work alongside, not instead of, estate-tax planning. Coordinating both is important for a complete strategy.
The structure of how the units pass to heirs (outright bequest, in trust, etc.) and how it fits your goals (providing for heirs, charitable giving, control) should be planned with your estate attorney, integrating the 721 exchange into your estate documents (will, trusts). So the 721 exchange is a component of your estate plan, coordinated with the rest. Coordinating with your estate plan — integrating the 721's income-tax benefits (deferral, step-up) with estate-tax planning, the bequest structure, and your overall wealth-transfer goals, with your estate attorney — is essential to using the 721 exchange effectively for estate planning. The 721 is a powerful component, but it works within your comprehensive estate plan. Understanding the need to coordinate ensures the 721 exchange's estate benefits are realized within a complete, professionally-planned estate strategy. The 721 exchange should be integrated into your estate plan, not used in isolation.
How Baker 1031 helps with estate planning
Baker 1031 Investments helps property owners use the 721 exchange for estate planning — explaining the deferral-plus-step-up combination, the divisibility benefit, and how the 721 compares to holding the original property, and coordinating with your estate attorney and CPA to integrate the 721 exchange into your comprehensive estate plan. We help you understand and capture the 721's estate-planning advantages for transferring real estate wealth to your heirs.
REIT units 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 involves securities (OP units), available to suitable investors after a review. We don't provide tax or legal advice (your CPA and estate attorney handle the tax and estate planning); we help you understand the 721's estate role and coordinate its execution with your estate professionals. Our role is to help you use the 721 exchange as a wealth-transfer tool — converting your property into diversified, divisible OP units that defer the gain during life and pass to heirs with the step-up — integrated into your estate plan. For estate-focused owners, the 721 exchange is a powerful tool, and we help you use it effectively within your broader plan.
Frequently Asked Questions
How does a 721 exchange help with estate planning?
By combining lifetime deferral with the step-up at death: you contribute property for OP units (deferring the gain), hold the units for life (earning income, deferring), and pass them to heirs at death, when the step-up in basis can erase the deferred gain. Plus, the units divide cleanly among multiple heirs (unlike a single property). So the 721 lets you defer the gain during life and eliminate it at death for heirs, while easing the division — making it a powerful wealth-transfer tool, all while gaining REIT ownership's benefits (diversification, liquidity, passivity).
How does the step-up in basis work on OP units?
When you die holding OP units, your heirs inherit them with a basis stepped up to the fair market value at your death — so their basis becomes the current value, not your old (low, carried-over) basis. This erases the deferred gain: e.g., units with a $1,000,000 deferred gain, worth $3,000,000 at your death, pass to heirs with a $3,000,000 basis, eliminating the embedded gain. Your heirs can then convert to shares or receive cash with little or no income tax on the prior appreciation. The step-up turns deferral into elimination of the gain for heirs.
Does holding OP units until death avoid the deferred tax?
For income-tax purposes, largely yes — if you hold the units until death, the step-up in basis can erase the deferred gain, so your heirs avoid the income tax on the prior appreciation that converting or selling during life would have triggered. So the deferral (during life) plus the step-up (at death) can eliminate the income tax on the deferred gain. (Estate tax is separate, depending on your estate's size and the estate-tax rules.) Holding until death is the key to the income-tax elimination — the central estate strategy of the 721 exchange.
Why are OP units good for dividing among heirs?
Because they're easily divisible — you can bequeath specific numbers of units to each heir, cleanly dividing your real estate wealth without forcing a sale or creating shared ownership. Each heir receives their units (with the stepped-up basis) and can independently hold, convert, or sell them, without being entangled with the other heirs in a shared property. This solves the problem of dividing an indivisible single property among multiple heirs. The divisibility of OP units is a major practical estate advantage, complementing the step-up.
Is the step-up unique to the 721 exchange?
No — holding your original property until death also gets a step-up (erasing the gain on that property). So the step-up itself isn't unique to the 721. The 721's added value is that it gives you the step-up plus other benefits: diversification (the REIT portfolio), liquidity (convertible units), passivity (no management), and divisibility (easy division among heirs). So if you want these benefits in addition to the step-up, the 721 provides them, while simply holding your property gets only the step-up (on your single, illiquid, indivisible property).
Why use a 721 instead of just holding my property until death?
Because the 721 gives you the step-up plus diversification, liquidity, passivity, and divisibility, which holding your single property doesn't. If you'd be content holding your concentrated, illiquid, management-intensive property until death (just for the step-up), you could — but the 721 lets you get the step-up while also diversifying (the REIT portfolio), gaining liquidity (convertible units), shedding management (passivity), and easing the division among heirs (divisible units). The 721 enhances the estate strategy beyond what holding the original property offers, for owners who want these benefits.
Does the 721 exchange avoid estate tax?
No — the step-up addresses income tax (the deferred gain), not estate tax. Estate tax is a separate tax on the value of your estate (including the units), which may apply depending on your estate's size and the estate-tax exemption and rules. So the 721's step-up eliminates the income tax on the deferred gain, but estate tax (if applicable) is a separate consideration your estate attorney plans for (using exemptions, trusts, gifting). The 721's income-tax benefits work alongside, not instead of, estate-tax planning. Coordinate both with your estate attorney.
What if I need income during my life?
The OP units pay distributions (comparable to REIT dividends) while you hold them, so you earn passive income during your life from the REIT's portfolio — without triggering the deferred gain. So you can hold the units for the income (and the deferral) during life, then pass them to heirs (with the step-up). The income during life and the step-up at death aren't mutually exclusive — you enjoy the distributions while holding, and the step-up applies at death. So the 721 provides lifetime income and the estate benefits together.
Can I pass OP units to heirs in a trust?
Yes — OP units can be held and passed through trusts as part of your estate plan, like other assets. The structure (outright bequest, in trust, etc.) is planned with your estate attorney to fit your goals (providing for heirs, control, asset protection, etc.). The step-up generally applies to assets included in your estate at death, and the specifics of trust structures and the step-up should be confirmed with your estate attorney. So you can integrate the OP units into trusts within your estate plan — the units are a flexible asset for estate structuring, coordinated with your attorney.
How do I coordinate a 721 exchange with my estate plan?
Integrate the 721's income-tax benefits (deferral, step-up) with your estate-tax planning, your bequest structure (how the units pass to heirs), and your overall wealth-transfer goals — with your estate attorney and CPA. The 721 is a powerful component, but it works within your comprehensive estate plan. Your estate attorney handles the estate-tax planning and bequest structure; your CPA handles the income-tax aspects; and the 721 exchange is integrated into your estate documents. Coordinating ensures the 721's estate benefits are realized within a complete strategy.
Is the step-up guaranteed to be available?
The step-up in basis at death is current law, applying to OP units as to other inherited assets. However, tax laws can change, so its future availability isn't guaranteed indefinitely — consult current sources and your advisors. Under current law, it's a powerful benefit central to the 721 estate strategy. As with any long-term tax planning, verify the current rules with your CPA and estate attorney, who monitor any changes to the step-up and estate-tax rules. Plan based on current law while staying aware that tax laws can evolve.
Who benefits most from the 721's estate features?
Older owners focused on transferring real estate wealth to heirs tax-efficiently — especially those with appreciated, low-basis property (large deferred gain to erase via the step-up), multiple heirs (benefiting from the divisibility), and a desire for diversification, liquidity, and passivity during their remaining years. For such owners, the 721 exchange's combination of lifetime deferral and income, the step-up at death, and the divisible units makes it an excellent wealth-transfer tool. Estate-focused owners ready to transition into REIT ownership benefit most from the 721's estate features.
Glossary
- Step-Up in Basis
- The death-time reset of basis to fair market value, erasing the deferred gain.
- Estate Planning
- Planning the transfer of wealth, aided by the 721's step-up and divisibility.
- Deferral During Life
- Holding OP units to defer the gain (and earn income) while living.
- Carryover Basis
- The low basis carried into the units, erased by the step-up at death.
- Fair Market Value
- The current value to which the basis steps up at death.
- Divisibility
- The ease of dividing OP units among multiple heirs.
- Deferred Gain
- The untaxed appreciation, erased for heirs by the step-up.
- Estate Tax
- A separate tax on the estate's value, distinct from the income-tax step-up.
- Wealth Transfer
- Passing real estate wealth to heirs, the 721's estate goal.
- OP Units
- The divisible, step-up-eligible holding from a 721 exchange.
- Bequest
- Passing units to heirs, structured in your estate plan.
- Trust
- A structure for holding/passing units within an estate plan.
- Distributions
- Lifetime income from OP units, alongside the deferral.
- Heirs
- Those who inherit the units with the stepped-up basis.
- Section 1014
- The code section providing the step-up in basis at death.
- Comprehensive Estate Plan
- The full plan into which the 721 exchange integrates.
Sources & References
- Cornell Legal Information Institute. 26 U.S. Code § 1014 — Basis of property acquired from a decedent
- Cornell Legal Information Institute. 26 U.S. Code § 721 — Nonrecognition of gain or loss on contribution
- IRS. Estate and Gift Taxes
- Nareit. What's a REIT (Real Estate Investment Trust)?
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.
