A key advantage of the 721 exchange over direct real estate is liquidity — the ability to access your wealth without selling an entire illiquid property. But this liquidity comes with nuances every investor should understand. Your OP units aren't directly liquid; to access market liquidity, you convert them into REIT shares (for a publicly-traded REIT, these are tradable on the market). However, converting units to shares is a taxable event, triggering the deferred gain on the converted units. So the liquidity is real but has a tax cost — and the degree of liquidity depends on whether the REIT is publicly traded or non-traded. Managing this liquidity wisely (often by converting gradually) lets you access your wealth while controlling the tax. This guide explains the liquidity path, the holding period, gradual conversion, traded vs. non-traded liquidity, and managing it with taxes.
The liquidity path
Understanding the liquidity path — from OP units to cash — is essential. Your OP units themselves aren't directly tradable on a market; they're a partnership interest. To access liquidity, you convert your OP units into REIT shares (typically one-for-one, after a holding period). For a publicly-traded REIT, those shares are liquid — tradable on the stock market — so once you've converted, you can sell the shares for cash. So the path is: OP units → REIT shares → cash (by selling the shares).
This path gives you liquidity that direct real estate lacks. Direct real estate is illiquid (selling takes time, and it's all-or-nothing — you can't easily sell part of a building). The OP-units-to-shares-to-cash path lets you access liquidity in portions (converting and selling some shares) and relatively quickly (for public REITs, selling shares is fast). So the 721 exchange provides a route to liquidity that a single illiquid property can't.
However, the path has a tax toll: the conversion step (OP units to REIT shares) triggers the deferred gain (a taxable event), so accessing the liquidity has a tax cost. The path is liquid, but not tax-free. Understanding the liquidity path — OP units to REIT shares to cash, providing portioned, relatively quick liquidity that direct real estate lacks, but with the conversion triggering the deferred gain — is the foundation for managing your post-721 liquidity. The path gives you flexible access to your wealth, with a tax cost at the conversion step. Understanding the path (and its tax toll) sets up how to access liquidity wisely. The liquidity path is the route from your OP units to spendable cash, with the conversion as the taxable gateway.
The holding period before conversion
Before you can convert OP units to REIT shares, there's typically a holding period — a minimum time you must hold the units before conversion is allowed. This holding period (often around one year, though it varies by REIT) is set by the operating partnership agreement and the REIT's terms. During this period, you hold the units (earning distributions, deferring the gain) but can't yet convert them to shares. So there's an initial period where conversion isn't available.
The holding period means liquidity isn't immediate after a 721 exchange — you must hold the units for the required period before the conversion-to-shares liquidity becomes available. So if you anticipate needing liquidity soon after the exchange, understand that the holding period delays the conversion option. This is a consideration in planning your liquidity needs around a 721 exchange.
After the holding period, the conversion option becomes available — you can then convert units to shares (triggering the tax) as you wish, accessing liquidity. So the holding period is an initial waiting time, after which the liquidity path opens. Many investors hold well beyond the minimum (for the income and deferral), converting only when they want liquidity. The holding period before conversion — the minimum time (often around a year) you must hold OP units before converting them to shares — means liquidity isn't immediate after a 721 exchange but becomes available after the holding period. Understanding the holding period helps you plan your liquidity timing, recognizing the initial waiting period before the conversion option opens. The holding period is an initial constraint on liquidity, after which the conversion path becomes available for accessing your wealth.
OP units typically have a holding period (often around a year) before you can convert them to REIT shares — so liquidity isn't immediate after a 721 exchange, but opens up after the holding period.
Converting gradually for liquidity
A key strategy for managing post-721 liquidity is converting gradually — converting and selling portions of your OP units over time, rather than all at once. Because converting triggers the deferred gain (taxable), converting all your units at once would trigger the entire deferred gain in one year, potentially a large tax bill. Converting gradually — say, a portion each year — spreads the gain recognition (and the tax) over multiple years, smoothing the tax impact.
Gradual conversion also matches your liquidity to your needs. Rather than converting everything (and holding cash or shares), you convert only what you need for liquidity when you need it, leaving the rest as OP units (deferring the gain, earning distributions). So you access liquidity incrementally, keeping the unconverted units working (deferred, income-producing). This aligns your liquidity with your actual needs while preserving the deferral on the rest.
This gradual approach is a common and prudent way to use the 721 exchange's liquidity — accessing your wealth over time as needed, spreading the tax, and keeping the bulk of your holding deferred and income-producing until you need it (or until the step-up at death erases the gain on what you never convert). Converting gradually for liquidity — converting and selling portions over time to spread the gain recognition (and tax) and match liquidity to your needs, keeping the rest deferred and income-producing — is the key strategy for managing post-721 liquidity. It smooths the tax impact and preserves the deferral on the unconverted units. Understanding gradual conversion shows how to access the 721's liquidity wisely, balancing your liquidity needs against the tax and the benefits of holding. Gradual conversion is how investors use the 721's liquidity efficiently over time.
Traded vs. non-traded REIT liquidity
The degree of liquidity you can access depends significantly on whether the REIT is publicly traded or non-traded. For a publicly-traded REIT, the REIT shares (which you convert your units into) trade on a stock exchange — so once converted, the shares are liquid, sellable on the market quickly and at market prices. So a traded REIT offers strong liquidity (after conversion) — you can readily sell the shares for cash.
For a non-traded REIT, the shares aren't listed on an exchange, so liquidity is more limited. Non-traded REITs typically offer liquidity through periodic share-repurchase programs (the REIT buying back shares, often subject to limits, discretion, and conditions) rather than open-market trading. So converting your units to non-traded REIT shares gives you shares that are less liquid than traded shares — liquidity depends on the repurchase program's availability and terms. The liquidity is more constrained.
So the REIT type matters greatly for your liquidity: a traded REIT offers robust, market-based liquidity (after conversion), while a non-traded REIT offers more limited, program-based liquidity. This is an important factor to understand before a 721 exchange, since the REIT you end up owning determines your liquidity. Traded vs. non-traded REIT liquidity — a traded REIT offering robust market liquidity (after conversion) versus a non-traded REIT offering more limited, repurchase-program-based liquidity — is a crucial distinction for your post-721 liquidity. The REIT type determines how liquid your converted shares really are. Understanding this difference helps you assess the liquidity you'll actually have, and choose (or understand) the REIT accordingly. The traded-vs-non-traded distinction is key to the real liquidity of a 721 exchange.
Managing liquidity and taxes together
The art of post-721 liquidity is managing liquidity and taxes together, since accessing liquidity (converting) triggers tax. The goal is to access the liquidity you need while minimizing and spreading the tax. This involves converting only what you need (not more), converting gradually (spreading the gain over years), and timing conversions thoughtfully (e.g., in years when your other income is lower, or to use available deductions, as your CPA advises). So you coordinate your liquidity access with tax planning.
The interplay means liquidity decisions are also tax decisions. Each conversion triggers gain (tax), so deciding how much to convert (and when) is a tax-planning exercise as much as a liquidity exercise. Your CPA helps model the tax of conversions, so you can access liquidity in a tax-efficient way (spreading and timing the gain). This coordination optimizes your after-tax liquidity.
The ultimate tax-management strategy is to hold units you don't need to convert — keeping them deferred (and income-producing) until the step-up at death erases the gain. So you convert only what you need for liquidity (paying tax on that), and hold the rest toward the step-up. This combines accessing needed liquidity with preserving the deferral (and the step-up) on the rest. Managing liquidity and taxes together — accessing needed liquidity by converting gradually and thoughtfully (with your CPA), while holding the rest toward the step-up — is how to use the 721's liquidity tax-efficiently. The coordination of liquidity and tax planning optimizes your after-tax access to your wealth. Understanding this management shows that post-721 liquidity is best handled as a combined liquidity-and-tax strategy, accessing what you need while minimizing and deferring the tax on the rest. Managing both together is the key to using the 721's liquidity wisely.
- The liquidity path is OP units → REIT shares → cash; converting units to shares triggers the deferred gain (taxable).
- There's typically a holding period (often around a year) before you can convert units to shares — liquidity isn't immediate.
- Convert gradually to spread the gain (and tax) over years and match liquidity to your needs, keeping the rest deferred.
- Liquidity depends on the REIT type — traded REITs offer robust market liquidity, non-traded REITs more limited program-based liquidity.
Liquidity planning strategies
Several liquidity planning strategies help you use the 721's liquidity effectively. The 'hold and convert as needed' strategy is the most common — you hold your OP units (deferring, earning income) and convert only portions as you need liquidity, spreading the tax and keeping the rest deferred. This balances liquidity access with the deferral and income, suiting investors who want occasional liquidity while keeping most of their wealth working.
The 'hold for the step-up' strategy is for investors who don't need much liquidity — they hold the units indefinitely (for income and deferral), converting little or nothing, and let the step-up at death erase the gain. This maximizes the deferral and the estate benefit, suiting estate-focused investors who can live on the distributions without needing to convert. So they prioritize the deferral and step-up over liquidity.
The 'planned gradual conversion' strategy is for investors who want to systematically access liquidity over time — converting a planned portion each year (e.g., for retirement income or other needs), spreading the tax and accessing liquidity steadily. This suits investors who want predictable, ongoing liquidity. So the strategies range from minimal conversion (hold for the step-up) to systematic conversion (planned gradual), with 'convert as needed' in between. Liquidity planning strategies — 'hold and convert as needed,' 'hold for the step-up,' and 'planned gradual conversion' — offer different ways to use the 721's liquidity based on your needs. Choosing the strategy that fits your liquidity needs and tax/estate goals lets you use the 721's liquidity effectively. Understanding these strategies helps you plan how to access your post-721 wealth in the way that best fits your situation. The right liquidity strategy depends on how much liquidity you need and your tax and estate priorities.
How Baker 1031 helps with liquidity
Baker 1031 Investments helps investors understand and plan post-721 liquidity — explaining the liquidity path (units to shares to cash), the holding period, the tax on conversion, the traded-vs-non-traded distinction, and the strategies for converting (gradually, as needed, or holding for the step-up). We help you understand the liquidity you'll actually have (depending on the REIT type) and plan to access it tax-efficiently.
OP units, REIT shares, 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 its liquidity involve securities, available to suitable investors after a review. We coordinate with your CPA on the tax of conversions, so you access liquidity in a tax-efficient way (spreading and timing the gain). Our role is to help you understand and use the 721 exchange's liquidity wisely — accessing your wealth when you need it, through gradual or planned conversion, while managing the tax and preserving the deferral (and step-up) on the rest. We help you make the 721's liquidity work for your needs, with clear expectations about the path, the holding period, the REIT type, and the tax.
Frequently Asked Questions
How do I get liquidity after a 721 exchange?
By converting your OP units into REIT shares (typically one-for-one, after a holding period) and then selling the shares for cash. For a publicly-traded REIT, the shares are liquid (tradable on the market). So the liquidity path is OP units → REIT shares → cash. However, converting units to shares triggers the deferred gain (a taxable event), so accessing the liquidity has a tax cost. The liquidity is real (especially for traded REITs) but not tax-free — converting is the taxable gateway to your liquidity.
Are OP units themselves liquid?
Not directly — OP units are a partnership interest, not tradable on a market. To access liquidity, you convert them into REIT shares (which, for public REITs, are tradable). So the units aren't directly liquid; the liquidity comes through converting to shares (taxable) and selling them. This means OP units are a longer-term, tax-deferred holding, with liquidity available indirectly via conversion. If you need direct, immediate liquidity, OP units don't provide it — you must convert (triggering tax) to access the market. The liquidity is indirect.
Is there a waiting period before I can convert?
Yes — there's typically a holding period (often around one year, though it varies by REIT) you must hold the OP units before conversion to shares is allowed, set by the operating partnership agreement and the REIT's terms. During this period, you hold the units (earning distributions, deferring) but can't yet convert. So liquidity isn't immediate after a 721 exchange — the conversion option opens after the holding period. Plan your liquidity needs around this initial waiting period, recognizing conversion isn't available right away.
Does converting OP units to shares trigger taxes?
Yes, generally — converting OP units to REIT shares (or redeeming for cash) is a taxable event that triggers the deferred gain on the converted units. So accessing liquidity via conversion has a tax cost. You can convert gradually (portions over time) to spread the gain and tax over multiple years, rather than triggering it all at once. To avoid triggering the gain, you hold the units (deferred) rather than converting — potentially until death, when the step-up can erase the gain. Conversion is the taxable step in accessing liquidity.
Why should I convert OP units gradually?
Because converting triggers the deferred gain (taxable), so converting all your units at once would trigger the entire gain in one year (a large tax bill). Converting gradually — a portion each year — spreads the gain recognition and tax over multiple years, smoothing the impact. It also matches your liquidity to your needs (convert only what you need when you need it), keeping the rest deferred and earning distributions. So gradual conversion spreads the tax and preserves the deferral on the unconverted units — a prudent way to access liquidity over time.
What's the difference between traded and non-traded REIT liquidity?
For a publicly-traded REIT, the shares you convert into trade on a stock exchange — so they're liquid, sellable on the market quickly at market prices (robust liquidity after conversion). For a non-traded REIT, the shares aren't exchange-listed, so liquidity is more limited — typically through periodic share-repurchase programs (subject to limits, discretion, and conditions) rather than open-market trading. So a traded REIT offers strong liquidity; a non-traded REIT offers more constrained, program-based liquidity. The REIT type significantly affects your real liquidity.
Can I access liquidity without triggering tax?
Largely no — the main liquidity path (converting units to shares) triggers the deferred gain. The distributions you earn while holding the units are income (taxed per the applicable rules) but don't trigger the deferred gain. To access your principal/wealth via liquidity, you convert (triggering gain). The only way to avoid triggering the gain is to hold the units (not convert) — but then you don't access that principal as liquidity. So accessing your wealth as liquidity generally has a tax cost (the conversion gain); the distributions provide income without triggering the deferred gain.
How much liquidity will I really have?
It depends on the REIT type and the conversion tax. For a traded REIT, after conversion your shares are quite liquid (market-tradable), so you can access substantial liquidity (net of the conversion tax). For a non-traded REIT, liquidity is more limited (program-based). And in both cases, converting triggers tax, so your net (after-tax) liquidity is less than the gross value. So your real liquidity depends on the REIT type (traded = more liquid) and the tax on conversion. Understand both factors to gauge your actual accessible liquidity.
What if I don't need liquidity?
Then you can hold your OP units indefinitely — earning distributions (income) and deferring the gain — without converting. If you hold until death, the step-up can erase the deferred gain for your heirs. So if you don't need liquidity, holding is an excellent strategy: you get income and deferral during life, and the step-up at death. Many investors hold their units long-term (living on the distributions) and never (or rarely) convert, maximizing the deferral and estate benefit. Not needing liquidity lets you fully use the deferral-plus-step-up strategy.
What's the best liquidity strategy?
It depends on your needs. 'Hold and convert as needed' (convert portions when you need liquidity, spreading the tax) suits investors wanting occasional liquidity. 'Hold for the step-up' (convert little or nothing, hold for income and the step-up) suits estate-focused investors not needing liquidity. 'Planned gradual conversion' (convert a set portion yearly, e.g., for retirement income) suits investors wanting systematic liquidity. Choose based on how much liquidity you need and your tax/estate priorities. Your advisor and CPA can help you select and implement the right strategy.
Should I choose a traded or non-traded REIT for liquidity?
If liquidity is a priority, a publicly-traded REIT offers more robust liquidity (market-tradable shares after conversion) than a non-traded REIT (limited, program-based liquidity). So for investors valuing liquidity, a traded REIT is generally preferable. However, the choice also involves other factors (the REIT's portfolio, quality, and your goals), and non-traded REITs have their own considerations. If post-721 liquidity matters to you, weigh the REIT's tradability heavily, since it determines your real liquidity. Discuss the REIT type with your advisor in light of your liquidity needs.
How do I manage liquidity and taxes together?
Access only the liquidity you need (convert only that much), convert gradually (spreading the gain over years), time conversions thoughtfully (e.g., in lower-income years, with your CPA's guidance), and hold the rest toward the step-up at death (erasing the gain on what you never convert). This coordinates your liquidity access with tax planning, optimizing your after-tax liquidity. Your CPA helps model the tax of conversions so you access liquidity tax-efficiently. Managing both together — accessing needed liquidity while minimizing and deferring the tax on the rest — is the key to using the 721's liquidity wisely.
Glossary
- Liquidity Path
- OP units → REIT shares → cash, the route to accessing wealth.
- Conversion
- Exchanging OP units for REIT shares, the taxable liquidity gateway.
- Holding Period
- The minimum time (often ~1 year) before units can convert to shares.
- Gradual Conversion
- Converting portions over time to spread the gain and tax.
- Publicly-Traded REIT
- A REIT whose shares trade on an exchange, offering robust liquidity.
- Non-Traded REIT
- A REIT without exchange-listed shares, with limited liquidity.
- Share-Repurchase Program
- A non-traded REIT's limited liquidity mechanism.
- Deferred Gain
- The gain triggered when you convert units to shares.
- Distributions
- Income from units, not triggering the deferred gain.
- Hold for the Step-Up
- Holding units toward the death-time step-up, minimal conversion.
- Planned Gradual Conversion
- Systematically converting a portion yearly for liquidity.
- Convert as Needed
- Converting portions when liquidity is needed.
- After-Tax Liquidity
- The net liquidity after the conversion tax.
- Step-Up in Basis
- The death-time reset erasing gain on unconverted units.
- Market Liquidity
- The tradability of traded-REIT shares after conversion.
- Tax Timing
- Choosing when to convert to manage the gain recognition.
Sources & References
- Cornell Legal Information Institute. 26 U.S. Code § 721 — Nonrecognition of gain or loss on contribution
- U.S. Securities and Exchange Commission. Investor.gov — Non-Traded REITs
- FINRA. Public Non-Traded REITs—Perform a Careful Review Before Investing
- Cornell Legal Information Institute. 26 U.S. Code § 1014 — Basis of property acquired from a decedent
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.
