Understanding how a 721 exchange works step by step demystifies what can seem like a complex transaction. At its heart, the process is straightforward: you contribute your property to a REIT's operating partnership and receive partnership units in return, tax-deferred. But getting there involves several steps — confirming the strategy fits you, finding a REIT willing to accept your property, valuing the property to determine your units, completing the contribution, and then managing your units over time (holding for income and deferral, or converting to shares for liquidity). Along the way, tax protection agreements and proper documentation matter. This guide walks through the 721 exchange process step by step, so you understand what's involved from initial assessment through holding (or converting) your units.
Step 1: Assess suitability and find an UPREIT
The first step is assessing whether a 721 exchange fits your goals and finding a willing UPREIT. Assessing suitability means confirming that transitioning into REIT ownership (diversified, passive, more liquid, generally one-way) aligns with your objectives — that you want diversification, liquidity, passivity, and estate benefits, and are comfortable giving up control and the ability to 1031. This assessment, with a financial professional and your CPA, ensures the 721 exchange is right for you before proceeding.
Finding a willing UPREIT is the other part of step one. Not every REIT will accept your particular property — the REIT must be an UPREIT (with an operating partnership), and it must want your property (fitting its portfolio strategy, quality standards, and acquisition criteria). So you (with your advisors) identify an UPREIT willing to accept your property in a 721 contribution. This can be a direct match (a REIT wanting your specific property) or, commonly, reached through a DST structured for a 721/UPREIT exit (the 1031-then-721 path).
This first step is foundational because it confirms both that the strategy fits you and that a viable UPREIT exists for your property. Without a willing UPREIT, there's no 721 exchange; without suitability, you shouldn't proceed. So step one establishes the feasibility and fit. Step 1 — assessing suitability (confirming the 721 exchange fits your goals) and finding a willing UPREIT (a REIT that will accept your property) — is the foundational step that establishes whether and how a 721 exchange can proceed. This step, done with professional guidance, ensures the strategy is right for you and a viable path exists. Getting step one right (confirming fit and finding an UPREIT) sets up the rest of the process. It's the essential starting point for any 721 exchange.
Step 2: Property valuation and OP unit determination
The second step is valuing your property and determining the OP units you'll receive. The UPREIT (and you) must agree on the value of your contributed property, because that value determines how many OP units you receive — you get units equal in value to your contributed property. So the property is appraised or valued (often through negotiation between you and the REIT, informed by appraisals and the property's financials), establishing the contribution value.
From the agreed property value, the number of OP units is determined based on the units' value (typically tied to the REIT's share price or net asset value, since OP units are convertible to shares). For example, if your property is valued at $5,000,000 and the OP units are valued at $50 each, you'd receive 100,000 OP units. So the property valuation and the unit value together determine your unit count, establishing your stake in the operating partnership.
This valuation step is important because it determines the value you receive (in units) for your property — a fair valuation ensures you get appropriate units for your property's worth. The negotiation balances your interest (maximizing your units for your property) and the REIT's (acquiring at a sound value). Step 2 — valuing your property and determining the OP units you'll receive (property value divided by unit value) — establishes your stake in the operating partnership in exchange for your property. A fair valuation ensures you receive appropriate units for your property's worth. Understanding this step clarifies how your property converts into a specific number of OP units, which is the economic heart of the exchange. The valuation and unit determination set the terms of your transition into REIT ownership.
Your property's agreed value, divided by the OP unit value (tied to the REIT's share price), determines how many units you receive — converting your property's worth into a specific stake in the operating partnership.
Step 3: The contribution
The third step is the actual contribution — transferring your property to the operating partnership in exchange for the OP units, the transaction that effects the 721 exchange. You contribute (transfer ownership of) your property to the REIT's operating partnership, and the partnership issues you the determined number of OP units. This contribution is the Section 721 transaction — tax-deferred, with no gain recognized at this point.
The contribution involves legal documentation (the contribution agreement, the transfer of the property, the issuance of the units, and often a tax protection agreement — discussed below), handled by the parties' attorneys and advisors. Your property's title transfers to the operating partnership, and you become a limited partner holding OP units. The contribution is structured to qualify under Section 721 for the tax deferral, which the tax and legal professionals ensure.
After the contribution, your property is part of the REIT's portfolio (held by the operating partnership), and you hold OP units representing your stake. The transition from property owner to OP unit holder is complete — you've exchanged your direct property for an interest in the REIT's operating partnership, tax-deferred. Step 3 — the contribution, transferring your property to the operating partnership in exchange for OP units (the Section 721 transaction, tax-deferred) — is the core transaction of the 721 exchange. It effects your transition from direct property owner to OP unit holder, with the gain deferred. The contribution, with its documentation and structuring, is where the exchange actually happens. Understanding this step clarifies the moment of transition: your property becomes OP units, tax-deferred, completing the conversion into REIT ownership. The contribution is the pivotal step of the process.
Step 4: Holding OP units
The fourth step — holding your OP units — is where you enjoy the benefits of the exchange over time. After the contribution, you hold OP units, which entitle you to distributions (comparable to the REIT's dividends) and represent your stake in the REIT's diversified portfolio. You earn passive income from the distributions while the deferred gain remains deferred (you haven't triggered it by converting or selling). So holding the units is the period of enjoying the income, diversification, and continued deferral.
During this holding period, you're a passive investor — the REIT manages the portfolio, and you collect distributions without management responsibilities. You can hold the units indefinitely, continuing the deferral and the income. There's typically a holding period (often around a year) before you can convert units to REIT shares, but you can hold well beyond that — many investors hold long-term for the income and toward the step-up at death.
Holding the units is also the period during which the estate-planning benefits accrue — if you hold until death, the step-up can erase the deferred gain for your heirs. So holding isn't just a passive waiting period; it's where the deferral, income, diversification, and estate benefits are realized over time. Step 4 — holding your OP units, earning distributions, with the deferral continuing — is where you enjoy the 721 exchange's benefits over time. As a passive investor, you collect income from the REIT's portfolio while the gain stays deferred, potentially toward the step-up at death. Understanding this step shows that the 721 exchange isn't just the transaction; it's the ongoing holding period where the benefits (income, deferral, diversification, estate planning) are realized. Holding the units is where the strategy pays off over time.
Step 5: Converting to REIT shares (or holding)
The fifth step — converting OP units to REIT shares, or continuing to hold — is where you decide how to handle liquidity and the eventual tax. After the holding period, you can typically convert your OP units to REIT shares (often one-for-one) or, in some structures, redeem them for cash. Converting gives you REIT shares, which (for public REITs) are liquid and tradable — so you can sell them for cash. But converting is generally a taxable event, triggering the deferred gain on the converted units.
So step five involves a choice: convert (gaining liquidity but triggering the tax) or continue holding (keeping the deferral and income). You can convert gradually — converting and selling portions over time as you need cash, spreading the tax — rather than all at once. Or you can hold indefinitely, never converting, and pass the units to heirs at death (with the step-up erasing the gain). The choice depends on your liquidity needs and tax planning.
Many investors hold the units long-term (for income and the step-up) and convert only as needed for liquidity (accepting the tax on what they convert). This flexibility — convert for liquidity (taxable) or hold for deferral (toward the step-up) — is a key feature of OP units. Step 5 — converting OP units to REIT shares for liquidity (triggering the tax) or continuing to hold for deferral and income (toward the step-up) — is the final step where you manage liquidity and the eventual tax. The flexibility to convert gradually or hold indefinitely lets you control the tax timing and liquidity. Understanding this step shows that the 721 exchange gives you ongoing options: access liquidity (converting, taxable) or preserve the deferral (holding). This flexibility is a defining benefit of holding OP units, completing the 721 exchange process.
- Step 1: Assess suitability (does the 721 fit your goals?) and find a willing UPREIT (or reach one via a DST 721 exit).
- Step 2: Value your property and determine the OP units you'll receive (property value ÷ unit value).
- Step 3: Complete the contribution — transfer property to the operating partnership for OP units (tax-deferred under Section 721).
- Steps 4–5: Hold the units (earning distributions, deferral continuing) and optionally convert to REIT shares for liquidity (triggering the tax) — or hold until death for the step-up.
Tax protection and documentation
Throughout the process, tax protection agreements and proper documentation are important. A tax protection agreement, negotiated as part of the contribution, can protect you from having your deferred (built-in) gain triggered if the operating partnership sells your contributed property in a taxable way during a protected period. This addresses the risk that a partnership sale of your property triggers your tax unexpectedly. Negotiating appropriate tax protection is an important part of the contribution step for many contributors.
Documentation is essential throughout — the contribution agreement (effecting the 721 transaction), the tax protection agreement, the OP unit issuance, the property transfer, and the partnership agreement (governing your rights as a limited partner). These documents establish your OP units, your rights, the tax protection, and the structure. Keeping them is important for the long term (the deferral, basis, and your rights persist for years). So proper documentation supports and protects your position.
The tax and legal complexity of these elements (the Section 721 structuring, the tax protection, the partnership agreement) is why the 721 exchange requires experienced professionals — a CPA, an attorney, and a securities-licensed advisor. Tax protection and documentation — the tax protection agreement shielding your gain from premature triggering, and the documentation establishing your units, rights, and the structure — are important elements throughout the 721 exchange process. Negotiating appropriate tax protection and maintaining proper documentation protect your position over the long term. Understanding these elements shows that the 721 exchange involves important legal and tax considerations beyond the basic steps, requiring professional handling. The tax protection and documentation are the safeguards that protect your deferral and rights throughout the process.
How Baker 1031 helps through the process
Baker 1031 Investments helps property owners through each step of the 721 exchange process — assessing suitability, finding a willing UPREIT (often via a DST structured for a 721 exit), navigating the property valuation and unit determination, executing the contribution, and managing the units over time (holding for income and deferral, or converting for liquidity). We coordinate with your CPA, attorney, and the REIT throughout.
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 help coordinate the tax protection and documentation with your professionals, ensuring your position is protected. Our role is to guide you through the 721 exchange process from initial assessment through holding (or converting) your units — making each step clear and ensuring it's handled correctly with the professional support the transaction requires. We help you navigate the process so your transition into REIT ownership is smooth, properly structured, and aligned with your goals.
Frequently Asked Questions
What are the steps of a 721 exchange?
Step 1: Assess suitability (does the 721 fit your goals?) and find a willing UPREIT. Step 2: Value your property and determine the OP units you'll receive. Step 3: Complete the contribution (transfer property to the operating partnership for OP units, tax-deferred under Section 721). Step 4: Hold the units (earning distributions, deferral continuing). Step 5: Optionally convert to REIT shares for liquidity (triggering the tax) or hold (toward the step-up at death). Tax protection and documentation matter throughout.
How do I find an UPREIT for my 721 exchange?
The REIT must be an UPREIT (with an operating partnership) and willing to accept your particular property (fitting its portfolio and criteria). You (with your advisors) identify a suitable UPREIT — either a direct match (a REIT wanting your specific property) or, commonly, reached through a DST structured for a 721/UPREIT exit (the 1031-then-721 path). Not every REIT will accept every property, so finding a willing UPREIT is part of step one. A securities-licensed advisor can help identify suitable UPREIT opportunities for your situation.
How is my property valued in a 721 exchange?
The UPREIT and you agree on your property's value (often through negotiation informed by appraisals and the property's financials), which determines how many OP units you receive. From the agreed property value and the unit value (typically tied to the REIT's share price or net asset value), the number of units is determined — e.g., a $5,000,000 property at $50/unit yields 100,000 units. A fair valuation ensures you receive appropriate units for your property's worth. The valuation is negotiated, balancing your interest and the REIT's.
What happens in the contribution step?
You transfer ownership of your property to the REIT's operating partnership, and the partnership issues you the determined number of OP units — the Section 721 transaction, tax-deferred (no gain recognized). It involves legal documentation (the contribution agreement, property transfer, unit issuance, often a tax protection agreement), handled by attorneys and advisors. After the contribution, your property is part of the REIT's portfolio, and you hold OP units. The contribution is the core transaction effecting your transition from property owner to OP unit holder, tax-deferred.
What do I do after receiving OP units?
You hold them — earning distributions (comparable to REIT dividends) while the deferral continues — as a passive investor (the REIT manages the portfolio). You can hold indefinitely, collecting income and continuing the deferral, potentially toward the step-up at death. After a holding period (often around a year), you can convert units to REIT shares for liquidity (triggering the tax) if desired. So after receiving units, you hold them for income and deferral, with the option to convert for liquidity later. Holding is where the benefits accrue over time.
How do I convert OP units to REIT shares?
After the holding period (often around a year), you can typically convert your OP units to REIT shares (often one-for-one) or, in some structures, redeem for cash, through the REIT's conversion/redemption process. Converting gives you REIT shares (liquid and tradable for public REITs), but it's generally a taxable event, triggering the deferred gain on the converted units. You can convert gradually (portions over time, spreading the tax) or all at once. Many investors convert only as needed for liquidity, holding the rest for deferral. The REIT facilitates the conversion.
What is a tax protection agreement in the process?
An agreement negotiated as part of the contribution that protects you from having your deferred (built-in) gain triggered if the operating partnership sells your contributed property in a taxable way during a protected period. It addresses the risk that a partnership sale of your property triggers your tax unexpectedly. The terms (protected period, form of protection) are negotiated. Securing appropriate tax protection is an important part of the contribution for many contributors, since it protects the security of your deferral. Your attorney negotiates the tax protection agreement.
How long does a 721 exchange take?
It varies depending on finding a willing UPREIT, the valuation negotiation, due diligence, and the documentation — the process can take weeks to months for the contribution itself. Unlike a 1031 (with its strict 45/180-day deadlines), the 721 exchange doesn't have those specific statutory deadlines (it's a partnership contribution, not a like-kind exchange), so the timeline is driven by the parties and the deal rather than fixed deadlines. After the contribution, holding the units is open-ended. The timeline depends on the specific transaction and parties.
Does a 721 exchange have 45- and 180-day deadlines?
No — those deadlines are specific to 1031 like-kind exchanges. A 721 exchange is a contribution of property to a partnership (under Section 721), not a like-kind exchange, so it doesn't have the 45-day identification or 180-day completion deadlines. However, if you reach the 721 via the 1031-then-721 path (a 1031 into a DST first), the 1031 portion has those deadlines, while the later 721/UPREIT exit doesn't. So the standalone 721 contribution isn't deadline-bound the way a 1031 is.
What documentation is involved in a 721 exchange?
The contribution agreement (effecting the 721 transaction), the tax protection agreement (if negotiated), the OP unit issuance documents, the property transfer documents, and the partnership agreement (governing your rights as a limited partner). These establish your units, rights, tax protection, and the structure. Keep them for the long term, since the deferral, basis, and your rights persist for years. The documentation is handled by the parties' attorneys and advisors, and you should retain complete copies. Proper documentation protects your position over the long term.
Do I need professionals for a 721 exchange?
Yes — the 721 exchange involves significant tax complexity (Section 721 structuring, basis, tax protection, the step-up), legal documentation (the contribution, partnership agreement, tax protection agreement), and securities (OP units). So you should work with an experienced CPA (tax), an attorney (legal structuring and documentation), and a securities-licensed advisor (the OP units). The complexity and securities nature make professional guidance essential. Don't undertake a 721 exchange without these professionals — their expertise ensures the process is handled correctly and your position is protected.
Can I reach a 721 exchange through a DST?
Yes — a common path is the 1031-then-721: 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/UPREIT exit, your DST interest is converted into OP units. This reaches REIT ownership through a DST, all tax-deferred. Many DSTs are structured with this potential 721 exit. If a future REIT transition matters to you, confirm the DST is structured for a 721/UPREIT exit before investing. We can help you find such DSTs.
Can I contribute property with a mortgage on it?
Often yes, but it adds complexity — when you contribute mortgaged property to the operating partnership, the partnership typically assumes or takes the property subject to the debt, and the treatment of that debt under partnership tax rules (how liabilities are allocated among partners) can affect your tax outcome and basis. In some cases, a reduction in your share of liabilities can be treated as a deemed distribution with tax consequences. This is a technical area, so the handling of existing debt is something your CPA and the REIT structure carefully. Discuss any mortgage with your advisors before contributing.
What if I change my mind after contributing?
Once you've contributed your property and received OP units, you generally can't reverse the transaction tax-free — the 721 exchange is a largely one-way move into REIT ownership (OP units aren't real property, so you can't 1031 out, and converting them to shares or cash is taxable). So you should be confident in the decision before contributing. Your options afterward are to hold the units (deferring, earning income), convert to shares for liquidity (taxable), or hold until death (step-up). This irreversibility is why the suitability assessment in step one is so important.
Glossary
- 721 Exchange Process
- The steps from assessment through holding/converting OP units.
- Suitability Assessment
- Confirming the 721 exchange fits your goals before proceeding.
- UPREIT
- The umbrella partnership REIT that must accept your property.
- Property Valuation
- Determining your property's value to set the OP units received.
- OP Unit Determination
- Calculating units from property value divided by unit value.
- Contribution
- Transferring property to the operating partnership for OP units.
- Section 721
- The code section making the contribution tax-deferred.
- Holding Period
- The time before OP units can typically convert to shares.
- Distributions
- Income paid on OP units while holding.
- Conversion
- Exchanging OP units for REIT shares, triggering the tax.
- Tax Protection Agreement
- A negotiated agreement shielding your gain from premature triggering.
- Contribution Agreement
- The document effecting the 721 transaction.
- Partnership Agreement
- The document governing your rights as a limited partner.
- Limited Partner
- Your role as an OP unit holder in the operating partnership.
- 1031-then-721 Path
- Reaching a 721 exchange through a DST's UPREIT exit.
- Built-In Gain
- The deferred gain that tax protection shields from triggering.
Sources & References
- Cornell Legal Information Institute. 26 U.S. Code § 721 — Nonrecognition of gain or loss on contribution
- IRS. Publication 541, Partnerships
- U.S. Securities and Exchange Commission. Investor.gov — Real Estate Investment Trusts (REITs)
- 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.
