Tax strategy: 721 exchanges
721 exchanges and UPREITs: the last exchange
Section 721 lets you contribute real estate to a partnership in exchange for an interest in it without recognising gain. When the partnership is a REIT's operating partnership, that turns a building you manage into units in a large, professionally run portfolio, and keeps the gain deferred.
Two routes
How owners get there
Direct contribution
You contribute your property straight to the operating partnership of a REIT in exchange for operating partnership units. Few REITs accept single properties, so this usually suits larger or well located assets.
Through a DST first
You 1031 exchange into a Delaware Statutory Trust interest. Later, the DST property is contributed to a REIT's operating partnership under IRC 721 and you receive units. This is the more common route for individual owners.
Why owners look at it
Ending the exchange cycle without ending the deferral
- No more finding, financing and managing replacement property.
- One property becomes a share of many, across locations and types.
- Units can be divided among heirs more easily than a building.
- Heirs generally receive a stepped up basis at death under IRC 1014.
The trade-offs
What you give up
| Trade-off | What it means |
|---|---|
| A one-way door | Operating partnership units are not real property, so you cannot 1031 exchange out of them later. |
| Taxable exits | Converting units into REIT shares, or selling them, is a taxable event that recognises the deferred gain. |
| Disguised sales | Cash or debt relief received around the contribution can be treated as a partial sale under IRC 707(a)(2)(B). |
| Debt allocation | If your share of partnership liabilities falls, it is treated as a cash distribution under IRC 752 and can trigger gain. |
| No control | You hold units in a large partnership. Management, sales and distributions are decided by the REIT. |
Where we fit
Connected with the right partner for the last move
A 721 exchange is close to permanent, so it deserves the most care. We hear you out on your property, your debt, your heirs and your income needs, and if this route fits, we connect you with a partner firm that works on these contributions.
- Debt and cash at contribution are planned so they do not trigger gain.
- The DST route is weighed against a direct contribution.
- Your CPA and estate attorney stay in the decision.
Questions
721 exchange questions
What is an UPREIT?
An umbrella partnership REIT. The REIT owns its properties through an operating partnership, and property owners can contribute real estate to that partnership in exchange for partnership units rather than selling it. IRC 721 generally allows that contribution without recognising gain.
Why would an owner choose this over another 1031 exchange?
Usually to stop exchanging. Each 1031 exchange means finding, buying and managing another property. Units in a large, diversified partnership end that cycle while keeping the gain deferred, and distributions come without landlord work.
What happens to the deferred gain at death?
Under IRC 1014, heirs generally receive a basis stepped up to fair market value at death. For many owners that is the point of holding units for life: the gain deferred through successive exchanges may never be taxed.
Can I change my mind later?
Only at a tax cost. Units can usually be converted into REIT shares or redeemed, but either recognises the deferred gain, and you cannot exchange back into real estate.