A two-step strategy moves an investor from a 1031 exchange into replacement real estate first, then later into an UPREIT under Section 721 if the sponsor and transaction structure allow it. The appeal is straightforward: continue tax deferral, reduce direct management, and eventually gain access to OP units that may offer more flexibility than owning property outright.
Why investors use this approach
Some property owners want to complete a valid 1031 exchange now but do not want to manage replacement property indefinitely. A later move into an UPREIT can offer a path from direct ownership to passive ownership while still deferring gain at the time of the contribution.
In practical terms, the strategy usually aims to combine two goals:
• Preserve 1031 tax deferral on the initial sale
• Transition later into a professionally managed real estate structure
That later transition is not a second 1031 exchange. It is a Section 721 contribution of qualifying real estate into an operating partnership tied to a REIT, with the investor receiving OP units instead of real property.
How the two-step strategy typically works
1. Sell the relinquished investment property and complete a 1031 exchange into replacement property.
2. Hold the replacement property as investment real estate.
3. If the structure permits, contribute that property, or in some cases a qualifying interest such as a DST interest, into an UPREIT transaction.
4. Receive OP units in the operating partnership rather than cash.
5. After any required holding or lockout period, redeem OP units for REIT shares or cash if allowed under the agreement.
This matters because once you move from real estate into OP units, you no longer hold real property for 1031 purposes. At that point, you generally cannot exchange back out of the OP units through another 1031.
Where DSTs often fit in
In many versions of this strategy, the replacement property is acquired through a Delaware Statutory Trust. The investor first uses a 1031 exchange to acquire the DST interest. After a holding period that is often described as two to three years, the sponsor may complete a Section 721 UPREIT transaction, and investors receive OP units.
That structure can attract investors who want hands-off ownership before eventually moving into a REIT-related vehicle. But it also depends on sponsor design, property performance, and whether the REIT is willing to complete the transaction.
Key considerations before pursuing it
• Control: You give up direct decision-making once real estate is contributed into the operating partnership.
• Liquidity: OP units may offer a future path to liquidity, but usually not immediately. Lockout periods can last a year or longer.
• Taxes: Tax is deferred, not eliminated. A taxable event may occur when OP units are sold, converted into REIT shares, or if the operating partnership sells the contributed property.
• No further 1031 from OP units: After the UPREIT step, the investment is no longer real estate for 1031 purposes.
• Execution risk: There is no assurance an UPREIT transaction will be available. It is subject to sponsor and REIT terms.
Frequently Asked Questions
Can I go directly from a 1031 exchange into an UPREIT?
Usually, not in a simple one-step sense if you need to satisfy 1031 rules first. Investors generally complete the 1031 into replacement real estate, then later pursue a Section 721 contribution if the property and sponsor structure support it. The sequence matters because 1031 applies to real property, while an UPREIT ends with OP units.
How long do I need to hold the replacement property before moving to an UPREIT?
There is no single universal timeline, but many two-step structures contemplate a holding period before the Section 721 contribution. In DST-based programs, that period is often described as two to three years. Investors should review the sponsor’s documents and consult tax and legal advisors about their specific facts.
What is the main tradeoff in moving from replacement property to OP units?
The main tradeoff is exchanging direct property ownership for a security-related partnership interest. This can reduce management responsibilities and improve future liquidity options, but it also means less control, potential market volatility, and the end of your ability to continue using 1031 exchanges on that investment once you hold OP units.
