A 721 exchange, also called an UPREIT, converts appreciated real property into operating partnership units of a Real Estate Investment Trust on a tax-deferred basis under IRC Section 721. The investor ends up holding OP units rather than property. Those units can be held indefinitely, exchanged over time into REIT shares, or passed to heirs at a stepped-up basis.

For owners of DST interests reaching the end of a hold period, the 721 option has become a common planned exit. It extends the tax deferral that began with the original 1031 exchange and converts the investment into a more permanent passive position. This article covers what the structure is, how investors typically arrive at it, and the trade-offs involved.

The structure in plain terms

A REIT that holds its real estate in an umbrella partnership (UPREIT structure) owns its properties through an operating partnership. The REIT itself is the general partner of that operating partnership. When a property owner contributes real property to the operating partnership in exchange for OP units, Section 721 of the Internal Revenue Code treats the contribution as a non-recognition event for federal tax purposes. No capital gains tax is due at the time of contribution.

The OP units carry economic rights similar to REIT shares. They receive the same per-unit cash distributions as REIT shareholders. They can be converted, after a lock-up period, into common REIT shares on a one-for-one basis. The conversion event is generally taxable in the year of conversion, which is why most investors hold the OP units directly rather than converting.

The DST-to-UPREIT pathway

Most 721 exchanges among individual investors do not involve direct contribution of real property. They happen through a DST. A DST offering structured with a planned UPREIT exit includes, at the end of the hold period, an option for the sponsor to transfer the DST's properties into a REIT operating partnership in exchange for OP units, which are then distributed to the DST beneficiaries.

The sequence an investor experiences runs through several steps. The investor executes a 1031 exchange from their relinquished property into DST interests. The DST holds the underlying property for several years and distributes cash flow. When the sponsor elects to proceed with the UPREIT transaction, the DST's property is contributed to the REIT operating partnership under Section 721. The DST then winds down, distributing OP units to the beneficial owners on a pro-rata basis. The investor now holds OP units in the REIT operating partnership, still with the tax basis that carried over from the original relinquished property.

The tax treatment of the 721 step itself is separate from the original 1031. The contribution to the operating partnership qualifies for non-recognition under Section 721 regardless of whether the investor's entry into the DST was a 1031 exchange. The combination extends the deferral that began with the sale of the original investment property.

Why investors choose the UPREIT path

A DST has a defined hold period. When the DST sells the property, the beneficiaries receive cash distributions and, absent planning, face capital gains recognition on the sale. Rolling the DST proceeds into another DST through a new 1031 exchange is possible but requires identifying and closing on the next DST within the 45-day and 180-day windows, which introduces the same timing constraints that prompted the original exchange.

The 721 alternative avoids that sequence. The transition from DST to OP units happens as a planned sponsor-level transaction, not a new exchange with independent deadlines. Several factors attract investors to the path.

  • Continued deferral without a new 1031. The UPREIT conversion uses Section 721 rather than Section 1031, which means the 45-day and 180-day identification windows do not apply.
  • Diversification across a REIT portfolio.OP units represent economic ownership across the REIT's entire portfolio, not a single DST property. For an investor moving out of a concentrated DST, the effect is a broader exposure without an additional exchange transaction.
  • Professional management at scale. Public and large non-traded REITs have operating teams, financing relationships, and research capabilities that few private investors can replicate.
  • Estate planning. OP units, like other appreciated assets, receive a step-up in basis at death. An investor who holds OP units through death can pass them to heirs with no deferred tax attached.

The trade-offs to understand

The 721 conversion is a real commitment. Several features cut in directions investors should consider carefully.

Loss of direct real-property ownership. After the 721 step, the investor owns OP units in an operating partnership, not a fractional interest in a specific property. Direct 1031 exchange treatment is generally not available for OP units going forward. An investor who later wants to return to direct property ownership cannot do so through a 1031 exchange of the OP units.

Performance tied to the REIT, not a specific property.OP unit distributions reflect the REIT's overall performance, not the performance of the originally contributed property. Investors evaluating a 721 exit should form a view on the REIT's portfolio, management, leverage profile, and capital discipline, not just on the original DST property.

Limited liquidity. OP units of non-traded REITs are generally illiquid. Even in publicly traded REIT structures, OP units are typically subject to lock-up periods before they can be converted to common shares. Secondary market liquidity for non-traded OP units is thin. The position is best held for the long term.

Conversion to REIT shares is taxable.When an investor converts OP units to common REIT shares (for example, to gain access to public market liquidity), the conversion generally triggers the deferred gain. Each investor's tax position after conversion depends on the accumulated basis and the REIT's share price at conversion.

Dilution and future capital events. The REIT may issue additional equity, acquire new properties, or undertake other corporate actions that affect OP unit value and distributions. OP unit holders typically do not vote at the REIT level, though operating partnership agreements vary.

Who the structure fits

The 721 path tends to fit investors with a long horizon, no near-term liquidity need, and an interest in consolidating their real-estate exposure into a single professionally managed position. It often appeals to older investors whose estate planning anticipates the step-up in basis at death, since that step-up eliminates the deferred gain for heirs.

It tends not to fit investors who want flexibility to re-enter direct real-estate ownership, who have shorter-term liquidity needs, or who prefer the operational control and tax transparency of direct property. An investor unsure about these trade-offs can often preserve optionality by staying in the DST through its scheduled disposition and considering the 721 decision closer to the election window.

Due diligence specific to 721 offerings

When a DST offering includes a planned UPREIT exit, the diligence extends beyond the DST property itself to the destination REIT. Useful review areas include the following.

  1. Portfolio composition and leverage.The OP unit position will reflect the REIT's overall risk profile, not just the DST property's.
  2. Conversion ratio methodology.OP units are exchanged at a ratio tied to the REIT's NAV or share price at the time of the transaction. The mechanism should be transparent and spelled out in the DST offering documents.
  3. Distribution history and sustainability.OP unit distributions will track the REIT's per-share distributions. Coverage by cash flow from operations is a reasonable indicator of sustainability.
  4. Lock-up and conversion provisions. Lock-up periods before OP units can be converted vary by sponsor. Longer lock-ups generally give the REIT more stability but reduce investor flexibility.
  5. Public, private, or non-traded status. Each carries different liquidity, reporting, and valuation dynamics. Public REIT OP units eventually offer public-market liquidity. Non-traded REIT OP units generally do not.

How the decision typically comes up

Most investors do not start with a 721 exchange in mind. They start with a sale, a 1031 exchange into a DST, and a hold period. As the DST approaches the end of its planned hold, the sponsor communicates whether an UPREIT conversion is on the table. At that point the investor chooses among three broad options: take the sale proceeds and pay tax, execute another 1031 into a new DST or other replacement property, or elect the 721 conversion into OP units.

The right choice depends on the investor's age, estate plan, liquidity needs, view of the destination REIT, and tolerance for adding complexity late in life. For many long-term holders, the 721 path is a cleaner extension of the deferral than running a new 1031 at the end of each DST hold. For others, the loss of direct property ownership outweighs the convenience. The structure is worth understanding before the question becomes urgent, which is the main reason to read about it in advance of the DST's maturity.