REITs and 1031 Exchanges: Why REIT Shares Don't Qualify

Not directly — you cannot 1031 exchange your relinquished real estate directly into REIT shares. The reason is fundamental: a 1031 exchange requires like-kind real property, and REIT shares are securities (personal property), specifically excluded from 1031 treatment, which since the 2017 Tax Cuts and Jobs Act is limited to real property. So exchanging real estate for REIT shares would be exchanging real property for a security — not like-kind, and not a valid 1031. However, there's a well-established indirect path: you can 1031 into a Delaware Statutory Trust (DST), which holds real estate and is recognized as like-kind for 1031 purposes, and then the DST's property can be acquired by a REIT via a 721 (UPREIT) exchange, converting your interest into REIT operating-partnership units tax-deferred. So you can reach a REIT tax-deferred via the DST-721 route, but not by directly 1031-ing into REIT shares. This is a common and important misconception to clear up.

Because they're securities, not like-kind real property. A 1031 exchange (Section 1031) defers tax only when you exchange real property held for investment or business for like-kind real property — and since the 2017 Tax Cuts and Jobs Act, Section 1031 is limited to real property (personal property and securities no longer qualify). REIT shares are interests in a corporation or trust — securities, personal property — not direct interests in real property. So even though a REIT owns real estate, owning REIT shares means owning a security (a share of the entity), not owning like-kind real estate. Exchanging real property for REIT shares would be exchanging real property for a security, which isn't like-kind and isn't a valid 1031. So the law's like-kind real property requirement excludes REIT shares — they're the wrong kind of property (a security, not real property). This is why a direct 1031 into REIT shares is impossible, regardless of REIT type.

It's the indirect, two-step path that reaches a REIT tax-deferred. First, you do a 1031 exchange from your relinquished property into a Delaware Statutory Trust (DST) — DSTs hold real estate and are recognized (under IRS Revenue Ruling 2004-86) as like-kind real property for 1031 purposes, so this step is a valid 1031 that defers your capital-gains tax. Then, at a later point, the DST's property is acquired by a REIT (or its operating partnership) via a 721 exchange (an UPREIT transaction) — you contribute your DST interest (real estate) to the REIT's operating partnership in exchange for operating-partnership (OP) units, tax-deferred under Section 721. So your real estate becomes OP units without triggering tax. Those OP units can later convert to REIT shares (though that conversion is taxable). So the DST + 721 workaround reaches a REIT tax-deferred — 1031 into a DST, then 721 into REIT OP units — without the impossible direct 1031 into shares.

OP units are ownership interests in a REIT's operating partnership — the partnership through which an UPREIT (umbrella partnership REIT) holds its properties. In a 721 exchange, you contribute real estate (such as your DST interest) to the operating partnership in exchange for OP units, tax-deferred under Section 721. OP units are economically similar to REIT shares (they typically receive distributions comparable to the REIT's dividends and track the REIT's value), but they're partnership units, not shares. The key feature is that the 721 contribution is tax-deferred, so you reach the REIT's economics without triggering tax on your original real estate gain. OP units can usually be converted to REIT shares over time — but that conversion is a taxable event (it's treated as a sale of the OP units). So OP units are the tax-deferred bridge into a REIT via a 721 exchange — REIT-like economics held in partnership form, with the deferral continuing until you convert to shares or sell.

Yes — fundamentally different in tax treatment and simplicity. Direct REIT investing means simply buying REIT shares (traded or non-traded) — a fully taxable purchase: you use after-tax dollars, and if you sold real estate to fund it, you first pay the capital-gains tax on that sale (no deferral). It's simple, liquid (for traded REITs), and immediate, but offers no 1031 tax-deferral. The 1031/DST-721 route, by contrast, defers the capital-gains tax from your relinquished real estate — you 1031 into a DST (deferring the tax), then 721 into REIT OP units (continuing the deferral) — so you reach a REIT-like investment without paying the capital-gains tax on your original sale. The trade-off is complexity, illiquidity, and the eventual tax when you convert OP units to shares or sell. So direct investing is simple and liquid but fully taxable, while the DST-721 route is complex and illiquid but tax-deferred — the right choice depends on whether you're deferring a real estate gain.

If you buy REIT shares directly after selling real estate, you pay the capital-gains tax on that sale up front — there's no deferral. You sell your property, pay the capital-gains tax (federal and state, plus any depreciation recapture), and invest the after-tax proceeds in REIT shares. So you've paid the full tax immediately. Going forward, you'll owe tax on the REIT dividends — mostly as ordinary income (with the 20% Section 199A deduction on qualified REIT dividends), plus tax on any return-of-capital portion (deferred, reducing basis) and on any share appreciation when you sell. So direct REIT investing has immediate tax consequences if it follows a real estate sale (the full capital-gains tax now), then ongoing dividend taxation. If you're investing cash (not from a real estate sale), there's no capital-gains tax to trigger — you just buy the shares. So the direct path's main tax feature is paying any real estate gain's tax up front, with no 1031 deferral. Consult your CPA.

The DST-721 route defers the capital-gains tax from your relinquished real estate. The 1031 into the DST defers it, and the 721 into OP units continues the deferral — so you don't pay the capital-gains tax on your original sale at that point. You'll receive distributions on the OP units (taxed similarly to REIT dividends — mostly ordinary income with the 20% deduction, plus any return of capital). The deferred gain remains deferred until a taxable event: notably, converting OP units to REIT shares is taxable (treated as a sale), as is selling the OP units. Importantly, a step-up in basis at death can potentially eliminate the deferred gain for your heirs (if you hold the OP units until death). So the DST-721 path defers the capital-gains tax (until conversion, sale, or potentially permanently via the step-up at death), while providing REIT-like distributions in the meantime. This deferral is the route's central tax advantage over a direct, taxable REIT purchase. Consult your CPA, as the mechanics are technical.

Yes — converting OP units to REIT shares is generally a taxable event. While the 721 exchange (contributing real estate for OP units) is tax-deferred, the later conversion of those OP units into actual REIT shares is treated as a sale of the OP units, triggering the deferred gain (and any additional gain) at that point. So the conversion ends the deferral. This is why investors often hold the OP units (rather than converting immediately) to maintain the deferral — and some hold them until death, when a step-up in basis can eliminate the deferred gain for heirs. So the path is: 1031 into a DST (deferred), 721 into OP units (deferred), then optionally convert to REIT shares (taxable) or hold/sell. The conversion to shares is the taxable step, not the 721 itself. So plan the timing of any conversion carefully with your CPA, recognizing it triggers the deferred tax — many investors delay or avoid conversion to preserve the deferral, especially if estate planning (the step-up) is a goal.

It depends on whether you have a real estate gain to defer and how you weigh tax-deferral against simplicity and liquidity. Choose the DST-721 route if you're sitting on appreciated real estate, want to defer the capital-gains tax, and want to transition toward REIT-style, professionally managed, diversified exposure — you 1031 into a DST and (where offered) eventually 721 into a REIT's OP units, deferring the tax. Choose direct REIT investing if you don't have a real estate gain to defer (you're investing cash), or you value simplicity and liquidity over deferral — just buy REIT shares (traded for liquidity, or non-traded if suitable). So the decision turns on your tax situation: the DST-721 route is for deferring a real estate gain (complex, illiquid, tax-deferred), while direct investing is for cash investors or those prioritizing simplicity and liquidity (simple, liquid, taxable). The DST-721 path also requires DSTs that offer a 721 option and careful structuring — professional guidance is essential.

A DST (Delaware Statutory Trust) is a 1031-eligible, illiquid real estate investment holding one or a few properties, with a defined hold and no daily pricing — it's the vehicle that lets you defer a real estate gain via a 1031 (and can lead to a REIT via a 721 exchange). A REIT (real estate investment trust), especially a traded one, is a liquid, diversified, professionally managed pool of many properties with daily pricing — but its shares aren't 1031-eligible. So the DST offers 1031 tax-deferral and direct real estate ownership (with illiquidity and concentration), while the REIT offers diversification and (for traded REITs) liquidity (but no 1031 entry). The DST-721 route bridges them — using the DST's 1031-eligibility to defer the gain, then a 721 to reach the REIT's diversification. So REITs and DSTs serve different roles: DSTs for 1031 deferral and direct ownership, REITs for diversification and liquidity. The DST-721 strategy combines the DST's deferral with the REIT's diversification — a powerful pairing for the right investor.

Yes — that's exactly the DST-721 route. You first do a 1031 exchange from your relinquished property into a Delaware Statutory Trust (DST), which is valid because DSTs are recognized as like-kind real property for 1031 purposes (under IRS Revenue Ruling 2004-86) — this defers your capital-gains tax. Then, when the DST's property is acquired by a REIT's operating partnership via a 721 (UPREIT) exchange, you contribute your DST interest for REIT operating-partnership (OP) units, tax-deferred under Section 721 — continuing the deferral and reaching the REIT's economics. So yes, the DST-then-REIT path works: 1031 into the DST (deferred), then 721 into REIT OP units (deferred). The key is that not all DSTs offer a 721 exit to a REIT — you need a DST structured with that option, and the timing of the 721 is determined by the sponsor/REIT, not you. So this route is available but requires the right DST and careful planning. Work with professionals to structure it correctly and confirm the 721 option exists.

The main reason is tax-deferral. If you're selling appreciated real estate, buying a REIT directly means paying the full capital-gains tax on that sale first (no deferral), then investing the after-tax proceeds. The DST-721 route lets you defer that capital-gains tax — you 1031 into a DST (deferring the tax) and then 721 into REIT OP units (continuing the deferral) — so you keep your full pre-tax proceeds working and reach REIT-style diversified exposure without the immediate tax hit. So the DST-721 route is valuable specifically when you have a real estate gain to defer and want to transition into a REIT tax-efficiently. If you're investing cash (no gain to defer), this advantage doesn't apply, and buying a REIT directly is simpler. So use the DST-721 route to defer a real estate gain while moving toward a REIT; use direct REIT investing if you have no gain to defer or prefer simplicity and liquidity. The deferral is the DST-721 route's key benefit for real estate sellers.

No — non-traded REITs, like traded REITs, are not 1031-eligible. Whether traded or non-traded, REIT shares are securities (personal property), not like-kind real property, so they don't qualify for a 1031 exchange (which since 2017 is limited to real property). So you can't 1031 directly into a non-traded REIT any more than a traded one. The traded/non-traded distinction affects liquidity, pricing, and fees — not 1031-eligibility (neither qualifies). The way to reach a REIT (traded or non-traded) tax-deferred is the DST-721 route (1031 into a DST, then 721 into OP units), not a direct 1031 into the REIT's shares. So don't assume a non-traded REIT can receive a 1031 exchange — it can't; it's still a security. Some non-traded REIT structures are involved in UPREIT/721 transactions (as the acquiring REIT in a DST-721 path), but the entry to the REIT via 1031 is through the DST and 721, never directly into the REIT shares. Confirm any structure with your advisors.

It depends on your priorities — there's no universal answer, and the two serve different needs. A DST is better if your priority is deferring a capital-gains tax from selling appreciated real estate (it's 1031-eligible, so you can roll your gain into it tax-deferred) and you want direct fractional ownership of specific properties — accepting illiquidity and a defined hold. A REIT is better if you want diversification across many properties, professional management at scale, and (for traded REITs) liquidity and daily pricing — but you'll forgo 1031 entry (buying shares is taxable). For many investors selling real estate, the most powerful answer combines both: use a DST to defer the gain via a 1031, then a 721 exchange to roll into a REIT's operating-partnership units — gaining the REIT's diversification while keeping the deferral. So 'REIT vs. DST' isn't strictly either/or; the DST-721 route can deliver the DST's tax-deferral and the REIT's diversification together. Match the choice to whether you're deferring a gain and how you weigh liquidity, diversification, and deferral — with professional guidance, since the structures and tax outcomes are consequential.

We help you understand why REIT shares don't qualify for a 1031, the DST + 721 workaround that reaches a REIT tax-deferred, direct REIT investing versus the 1031 route, and the tax implications of each — so you can plan the right route into a REIT for your tax situation and goals, and access suitable investments. DST, REIT, and related securities interests are offered through the broker-dealer, Aurora Securities, Inc. (member FINRA/SIPC), and any recommendation follows a suitability review (DSTs and non-traded/private REITs are typically for accredited or suitable investors; traded REITs are accessed through a brokerage account). We specialize in 1031 and DST strategies, so we can help you evaluate whether the DST-721 route fits (to defer a real estate gain while moving toward REIT-style exposure) or whether direct REIT investing is more appropriate. We don't provide tax or legal advice (your CPA and attorney handle the 1031, 721, and conversion mechanics). We help you plan your route into a REIT — direct or via DST-721 — with clear understanding of the rules, coordinating with your tax and legal professionals.