Structures
The 721 Exchange, and Why It Only Works Once
Rolling into an UPREIT gives you liquidity and diversification. It also ends your ability to keep exchanging, permanently.
Illustration generated for this article by 1031 Exchange News Today.
A 721 exchange, sometimes called an UPREIT roll-up, contributes property into a REIT's operating partnership in return for operating partnership units. It converts a building into something that behaves like a liquid security, and it is the last 1031-adjacent move you will ever make with that property.
It is not a 1031 exchange
Worth being blunt about, because the naming invites confusion. Section 1031 defers gain on a like-kind swap of real property. Section 721 defers gain on a contribution of property to a partnership in exchange for an interest in it. Different section, different mechanism, similar outcome.
The two are often used in sequence: a 1031 exchange into a DST, and then, when the sponsor rolls that DST into the REIT, a 721 exchange into operating partnership units.
What you get
- Diversification across the REIT's whole portfolio rather than one building.
- Genuine passivity. No tenants, no capital calls, no decisions.
- Quarterly distributions in place of rent.
- OP units generally convertible to REIT shares, which are liquid.
The conversion is the taxable event
Holding OP units is not taxable. Converting them to REIT shares generally is, because it is treated as a disposition of the partnership interest. So the liquidity is real but it is not free: the day you use it, the deferred gain from the original property arrives.
| You hold | Can 1031 again? | Liquid? |
|---|---|---|
| Direct real property | Yes | No |
| DST beneficial interest | Yes, on sponsor's timing | No |
| OP units after a 721 | No, permanently | On conversion, which is taxable |
| REIT shares | No | Yes |
Who it suits
Investors at the end of the road. Someone in their seventies who has exchanged four times, wants no further management, wants income, and intends to hold until death so heirs take the step-up. For that person the one-way door is not a cost, because they were not going through it again anyway.
It suits a forty-year-old accumulating property considerably less well, because it closes off the strategy that got them there.
Disclosure
This article is published by Easy1031, a qualified intermediary with a commercial interest in readers starting an exchange. The rules and mechanics described here are the same whichever intermediary you use. Nothing here is tax or legal advice.
