How Does a 721 Exchange Work? A Step-by-Step Walkthrough (2026)

How does a 721 exchange work?

So how does a 721 exchange work? A 721 exchange takes real estate you already own and contributes it to a REIT, giving the exchanger ownership in the REIT via operating partnership units. A qualifying contribution generally does not trigger immediate gain, though exceptions can apply. The deferral comes from IRC Section 721.

For many investors, one potential route has two steps: a 1031 exchange into a Delaware Statutory Trust first, and then a few years later, the REIT absorbs that DST interest through a 721.

Now, before specifically selecting this particular tax strategy, all investors should first speak to their tax advisor or CPA to make sure it's the best option for them and their families.

Hi, I'm Steve Haskell, Partner at Anchor1031, and I've spent my career helping investors place hundreds of millions of dollars into DSTs, REITs, and private securities. And my job is to help investors analyze the risk as they review their due diligence and help uncover the risk before you commit.

This video is based on the 1031 investor guide written by my partner, Tom Wall. You can download it for free at the link in the description.

This is the sequence for the owner who has held rental property for decades and is ready to stop management for good. Here's exactly what happens between the day one sells and the day one holds the OP units in the REIT, who does what, and what paperwork lands on your desk at each step.

Which of the two 721 paths applies to you?

Which of the two 721 paths apply to you? There are typically two paths into a REIT operating partnership under IRC Section 721, and nearly every individual investor ends up on the same one.

The first is a direct 721 contribution. This happens when an institutional owner contributes one large property, typically more than $10 million, straight into the REIT in exchange for OP units. The REIT has to want that specific asset, and the deal is negotiated one-on-one between the seller and the REIT. If you are selling a rental house or a small apartment building, that door is almost never open to you.

The second is the two-step DST-to-UPREIT sequence, and that is one potential route for investors. First, you sell your property through a standard 1031 exchange, then you acquire a beneficial interest in a DST that is structured to be acquired by a REIT in a few years. You will then hold it through a seasoning period, and then you contribute that interest to the REIT's operating partnership under Section 721.

The rest of this video is about the two-step path because it's the route most relevant to individual investors. But again, first, speak to your CPA and tax advisor to make sure that is the best option for you.

What are the six steps of a DST-to-UPREIT 721 exchange?

So what are the six steps of a DST-to-UPREIT 721 exchange? Typically, six steps carry your equity from a property you own directly all the way up to OP units in a diversified REIT.

Step one, sell your relinquished property. A qualified intermediary has to be engaged before closing so the proceeds never touch your hands. The QI holds the funds, and the 45-day identification and 180-day exchange deadlines start running the day you transfer title.

Step two, complete the 1031 exchange into an UPREIT-eligible DST. Within 45 days, you identify replacement property. Within 180 days, you close on that property. Not every DST carries a 721 path. Some are structured for REIT absorption and usually labeled 721 Required or 721 Optional. And some are traditional hold-to-maturity strategy with no 721 option at all, and are typically eventually placed on the market to sell to the potential best offer.

Now, step three, hold the DST interest through the seasoning window. Industry compliance practice, it's not a statute, but a practice, is to hold for at least two years before the 721 contribution. This gap protects against step-transaction risk, where the IRS could recharacterize the whole sequence as a prearranged transaction instead of two separate exchanges. During the hold, you receive monthly or potentially quarterly distributions and an annual 1099 and tax packet from the DST sponsor. Now, there are never any guarantees of this cash flow. This is real estate. It has risk, so therefore, cash flows can go up, down, or stop.

Step four, the REIT sponsor triggers acquisition of the DST. In a 721 Required offering, it happens automatically on the sponsor's timeline, typically two or three years after closing. In a 721 Optional offering, the investor elects to take OP units or takes cash when the window opens. And one compliance point: a DST marketed as 721 eligible is offering the possibility, not a guarantee. If the DST does not perform as a standalone investment, the 721 path may not exist, or the sponsor may choose not to UPREIT that particular asset.

Step five, you receive OP units. Your cost basis then carries over from the original property through the DST and into the units. The built-in gain is tracked to you personally under IRC Section 704(c), and no gain is recognized at the contribution under Section 721. You will now receive an annual K-1 from the REIT's operating partnership. Again, speak to your CPA and tax advisor when going through these steps.

Step six, you choose the end game. Converting OP units into REIT shares is recognized as a taxable event under IRC Section 731 and will trigger a tax consequence. Holding the units until death positions the investor’s heirs for a step-up in basis under IRC Section 1014, which under current law can eliminate the deferred gain. Congress has repeatedly floated proposals to limit the step-up, so confirm the current treatment with your estate attorney and your tax advisors before you rely on it.

How long does a 721 exchange take?

So how long does a 721 exchange take? A 721 exchange can potentially take about two and a half to three years. Usually, that's the fastest, from the sale of your property to the day you hold OP units in the REIT. It could potentially take longer depending on the sponsor's absorption schedule.

So the active work is front-loaded. The 1031 leg takes focused attention for the first 180 days: identifying replacement property, reading the private placement memorandum, signing subscription documents. All that goes into the front end when acquiring the DST. Once the DST closes, the hold is passive.

Somewhere around year two or three, either the 721 Required conversion triggers on its own or you make your own 721 Optional election. After absorption, you hold OP units in the REIT's operating partnership, and some investors intend to hold them for life because the step-up in basis upon death is often the estate planning reason they chose the 721 path in the first place.

What documents will you sign at each step of a 721 exchange?

What documents will you sign at each step? The documents you sign in a 721 exchange are different at every one of the six steps, and knowing them in advance removes most of the mystery.

At step one, the property sale, you sign the QI exchange agreement before closing, and you receive the settlement statements.

Step two, the 1031 into the DST, you get the private placement memorandum, the subscription agreement, and the suitability questionnaire. The PPM is the binding disclosure document. Read it in full before you sign, not after. And again, make sure you consult with your tax advisors and consultants before making the decision.

At step three, that's the DST hold, you receive potential quarterly or monthly distributions and a substitute 1099 at the end of the year that goes on the Schedule E of your tax return.

At step four, at the REIT absorption, you receive the REIT prospectus or a supplemental offering memorandum and the OP contribution agreement. In a 721 Optional offering, there is also an election notice asking whether you choose units or cash.

At step five, you receive the OP unit certificate or a confirmation of partnership interest, and from then on, your K-1 comes from the REIT's operating partnership.

At step six, if you do convert, there is a conversion request notice, a REIT share certificate or account statement, and a Form 1099-DIV for the dividends after that.

Now, we walk every client through the list before they sign anything at step one. The right time to understand what you are committing to is before you close the sale, not at the redemption window or two years later.

What can go wrong at each step of a 721 exchange?

What can go wrong at each step? Well, let's go through it. What are some of the things that can go wrong at each step in the process? Every step of a 721 exchange has a point of failure, and naming them is what turns each step into a decision instead of an assumption.

In steps one and two, the 1031 leg, missing the 45-day identification deadline disqualifies the entire exchange. Taking cash or non-like-kind property is boot and triggers an immediate tax bill. Debt matching matters. A 1031 has to replace the debt you gave up or replace that debt with cash to buy property of equal or greater value, or the shortfall is taxed as boot. The leverage on the 721-eligible DST is set by the sponsor, and it may be lower than the mortgage on the property you sold. If it is, the difference is boot unless you add cash or pair the offering with a second DST that carries more debt. Match the DST's loan to value to your relinquished debt before day 45, or add cash to make sure you're buying property of equal or greater value. Make sure you speak to your CPA or tax advisor once again to make sure you're buying enough real estate to defer all of your taxes.

In step three, the hold. The DST underperforms, the sponsor extends the hold, or the REIT decides not to absorb the property at all, and you exit through a traditional DST disposition instead. None of those are catastrophic, but they change the plan. And the investor who bought solely for the 721 option is the one caught off guard.

In step four, absorption. In a 721 Required structure, the conversion can happen at a depressed net asset value if the market has fallen. The sponsor's appraisal sets the number, and you have no election. In a 721 Optional structure, the window can close before conditions improve.

In step five, investors need to be aware of what's called the disguised sales trap under IRC Section 707(a)(2)(B). If you take a distribution and pull it from the partnership near the time of your contribution, the IRS may characterize the exchange as a taxable sale. The fix is simple: no distributions close to the contribution date, and talk to your CPA about the safe harbor timing. Talk to your advisor more to understand that situation in further detail.

Step six, conversion. Converting all your OP units in one tax year triggers the whole deferred gain at once. Converting in stages across several years is the common way to manage that. So speak to your CPA when you're liquidating your OP units.

Finally, what many people don't know is that even though the distributions from the OP units in the REIT may be derived from a diversified REIT with rental income generated from potentially billions of dollars of real estate, your basis is still tied to the property that you originally 1031 exchanged into, so that DST property. So if the REIT sells that particular property, it could trigger a taxable event, even if you are still holding the OP units and didn't convert them. So be aware to talk to the sponsor before doing a 721 into that to make sure you know what their strategy is for that particular asset in the REIT.

Should you keep swapping DSTs or 721 into a REIT?

So should you keep swapping DSTs or 721 into a REIT? Both strategies have merit, and it is not all or nothing.

Staying in the DST lane keeps your 1031 optionality. It lets you underwrite a new sponsor and asset every five to seven years, and it keeps each offering on its own balance sheet. Crossing into a REIT through a 721 trades that control for permanent passivity, portfolio diversification, and a cleaner estate plan.

One thing we remind every client at this stage: you can split one 1031 exchange across several DSTs. That means you could hold a 721 Required DST and a traditional exit DST in the same exchange. And according to us at Anchor1031, the investors who are happiest after a 721 are the ones who wanted to be finished making real estate decisions, not the ones who still like the option. So if evaluating another DST at maturity feels like a burden rather than an opportunity, the REIT may be a better final destination.

In a 721 exchange, it's typically a sequence, and each step builds on the one before it. Start with your CPA to confirm your deferred gain exposure, your estate attorney to confirm the step-up strategy works under your state's rules, and a conversation about which structure fits your timeline: a 721 Required, a 721 Optional, or a traditional DST with no 721 at all.

If you want to map these six steps to your specific property timeline and estate plan, the link to schedule a walkthrough with us at Anchor1031 is in the description, along with the full written guide and every other video in this series.