A 721 exchange, sometimes marketed as an UPREIT exchange, is a two-step path that moves an owner from direct real estate ownership toward shares in a real estate investment trust without a taxable sale at either step, but it is a different legal mechanism from a Section 1031 exchange and the two should not be confused.
The first step is typically a standard 1031 exchange into a DST interest. The second step, which can happen later, contributes that DST interest to a REIT's operating partnership in exchange for operating partnership units under Section 721, a tax-deferred contribution rather than a like-kind exchange.
Investors sometimes assume the 721 contribution step is automatically available once they hold a DST interest, but sponsors that offer this path typically disclose it, and any conditions attached to it, in the original DST offering documents, so that disclosure should be reviewed at the time of the initial investment, not assumed later.
Section 1031 defers gain on an exchange of like-kind real property for other like-kind real property. Section 721 defers gain on a contribution of property to a partnership in exchange for a partnership interest, which is a different transaction with its own statutory requirements and is not itself a real estate exchange at all.
Because OP units are a partnership interest rather than real property, once a DST interest converts into OP units, that position can no longer be exchanged into another property under Section 1031; the 1031 chain effectively ends at that point.
The REIT's operating partnership agreement, not the original DST trust agreement, governs the terms of the OP units once the contribution is completed, including distribution rates, redemption rights, and any lock-up period before units can be converted to shares.
An investor typically completes a 1031 exchange into a DST interest first, holds it for a period consistent with the sponsor's stated investment intent, and then, if the sponsor offers this exit, contributes the DST interest to the REIT's operating partnership for OP units. Not every DST sponsor offers this path, and it is arranged at the sponsor's discretion, not guaranteed at the time of the original DST investment.
OP unit holders generally receive distributions similar to REIT shareholders and can typically convert units to REIT shares over time, though conversion is usually taxable when it happens, since it is a sale of the partnership interest for stock rather than a further tax-deferred step.
Because the contribution of a DST interest to an operating partnership is itself a transaction with its own timing and documentation requirements, investors should coordinate with both the DST sponsor and their tax advisor well before the DST's planned exit date, rather than treating the 721 step as a formality.
A DST interest carries the illiquidity typical of any private placement. OP units are somewhat more liquid in that they can often be converted to REIT shares, but that conversion is a taxable event, so the tax deferral chain from the original property sale effectively terminates once an investor converts.
REIT ownership through OP units diversifies exposure across the REIT's broader portfolio rather than concentrating risk in one DST's specific properties, which is the main reason owners pursue this path despite giving up further 1031 eligibility.
OP unit distribution rates are set by the REIT's operating partnership and can differ from the income the same investor was receiving from the original DST, since the underlying assets and the REIT's overall capital structure are now different from the single DST's specific property.
Heirs who inherit OP units, like heirs who inherit real property directly, generally receive a stepped-up basis at death, which can eliminate the deferred gain built up through the DST-to-OP-unit path entirely, though this depends on the specific facts and current law at the time of death and is not guaranteed.
Because this is a significant, largely irreversible decision, it warrants review with both the investor's tax advisor and the sponsor's offering documents before any DST interest is contributed to an operating partnership.
Because converting OP units to REIT shares is generally taxable, some investors choose to hold OP units indefinitely specifically to preserve the deferral, treating the eventual step-up in basis at death as the intended resolution of the deferred gain rather than a lifetime conversion to shares.
A contribution of a DST interest to an operating partnership under Section 721 is reported differently than a like-kind exchange, and the investor's tax basis in the resulting OP units carries over from their basis in the DST interest, which itself traces back to the original relinquished property's basis.
Because this reporting differs from the Form 8824 filing used for a 1031 exchange, investors should confirm with their tax preparer that the contribution is documented correctly in the year it occurs, distinct from any earlier 1031 exchange reporting tied to the original DST investment.
