The two-step path
A 721 exchange (named for Section 721 and also called an UPREIT transaction) lets an investor contribute real property — or a DST interest — into a real estate investment trust's operating partnership in exchange for OP units, without triggering tax at the moment of contribution.
For DST investors this is often a two-step strategy: first a 1031 exchange into a DST, then, at a later date, a 721 contribution of that DST's property into the sponsor's REIT for OP units. The result is a move from owning a slice of one or a few buildings to owning an interest in a diversified portfolio.
Why investors consider it
- Diversification. OP units represent a stake in the REIT's whole portfolio rather than a single asset.
- Potential liquidity. OP units can typically be converted into REIT shares over time, which may then be sold — a path to liquidity that a single DST does not offer.
- Estate planning. Units can be divided among heirs more easily than a building, and heirs may receive a step-up in basis.
- Continued deferral. The contribution itself is generally not a taxable event, so gain continues to be deferred at that step.
The tradeoffs
- You generally cannot 1031 out again. Once you hold OP units or REIT shares, you own a security, not direct real property — so you typically lose the ability to do a future 1031 exchange. This is often the most important consequence.
- Converting or selling is taxable. Converting OP units to REIT shares, or selling them, is generally a taxable event that can trigger the deferred gain.
- Loss of control and asset specificity. You exchange a known property for a stake in a manager-run portfolio whose composition can change.
- One-way door. The move into the REIT is generally not reversible.
A 721/UPREIT step is a significant, often irreversible decision with meaningful tax consequences. It should be evaluated with your own tax and legal advisors against your liquidity needs and estate plan.
- A 721 exchange contributes property (or a DST interest) into a REIT's operating partnership for OP units, deferring gain at that step.
- It is often the second step after a 1031 into a DST, trading single-asset ownership for a diversified REIT portfolio.
- Benefits include diversification, a potential path to liquidity, and estate-planning flexibility.
- The key tradeoff: once you hold OP units, you generally can no longer do a 1031 exchange, and converting or selling units is taxable.
- The move is generally irreversible — weigh it carefully with your advisors.