You complete a 721 exchange by contributing qualifying investment real estate to a REIT operating partnership, usually after advance underwriting, valuation, legal review, and closing coordination, in exchange for OP units instead of cash. Many investors first complete a 1031 exchange into a property or DST that fits the REIT’s requirements, then later move that asset into the UPREIT.
Start With Eligibility and Planning
A 721 exchange is not a simple property sale. It involves contributing property to a REIT’s operating partnership in exchange for OP units. That structure can defer gain recognition, but only if the transaction is properly structured and the REIT accepts the asset.
Before moving forward, confirm three basic points:
• The property is held for investment or business use.
• The REIT or sponsor is willing to accept that type of property.
• Your tax, legal, and investment advisors agree the strategy fits your goals.
Not every property will qualify. REITs typically evaluate location, asset quality, income profile, and how the property fits their portfolio.
Follow the Typical 721 Exchange Process
Most 721 exchanges follow a practical sequence:
1. Review your property and goals.
Start by assessing value, embedded gain, debt, expected cash flow, estate planning goals, and how much management responsibility you want to give up.
2. Identify a suitable REIT or 721 program.
The sponsor must decide whether your property fits its acquisition standards. If it does not, you may need another route.
3. Complete due diligence and valuation.
The REIT will typically conduct its own underwriting and appraisal. The agreed value affects how many OP units you receive.
4. Structure the transaction documents.
Your legal and tax professionals will review the contribution agreement, partnership terms, debt treatment, and transfer mechanics.
5. Close the contribution.
At closing, you transfer the property to the operating partnership and receive OP units. At that point, you no longer directly own the real estate.
6. Hold the OP units.
You may receive distributions tied to the operating partnership, but OP units are generally subject to restrictions and are not the same as publicly traded shares.
7. Convert later only if appropriate.
After any required holding period, you may be able to convert OP units into REIT shares or cash, but that conversion is generally a taxable event.
When a 1031 Exchange Comes First
In many cases, investors do not move directly from their original property into a 721 structure. A common path is:
• Sell the relinquished property through a 1031 exchange
• Acquire replacement property or a DST interest
• Hold that asset for a period, often 12 to 24 months
• Contribute that qualifying asset into the UPREIT for OP units
This approach can help when the original property does not meet the REIT’s requirements or when the investor wants more flexibility while evaluating 721 options.
Key Considerations Before You Proceed
A 721 exchange can reduce management burden and broaden exposure across a larger real estate portfolio, but it also changes the nature of what you own. You move from direct real estate ownership to partnership units. That means less control, possible lock-up periods, and tax consequences when units are converted or redeemed.
It is also important to understand that once you receive OP units, you generally cannot exchange those units back into real property through another 1031 exchange.
Frequently Asked Questions
Can I complete a 721 exchange directly from my rental or commercial property?
Yes, if the REIT or sponsor accepts your property and the transaction is properly structured. In practice, not every property meets a REIT’s standards, so some investors first complete a 1031 exchange into a qualifying property or DST before moving into a 721 exchange later.
How long do I have to hold OP units before converting them?
That depends on the partnership agreement. Many 721 structures impose a holding or lock-up period before OP units can be converted into REIT shares or redeemed for cash. Even after that period ends, conversion is usually taxable and should be reviewed with your tax advisor first.
Is a 721 exchange better than a 1031 exchange?
Not necessarily. A 1031 exchange keeps you in direct real estate ownership and preserves the ability to continue exchanging into other real property. A 721 exchange can reduce active management and offer broader diversification, but it typically ends your ability to use future 1031 exchanges on that contributed asset.
