Real estate eligible for a Section 721 exchange is generally investment or business-use property that a REIT wants to acquire through its operating partnership. In practice, that usually means appreciated commercial real estate, and in some cases property first exchanged into a DST and later contributed into an UPREIT, if the sponsor offers that option.
What qualifies for a Section 721 exchange
A Section 721 exchange lets a property owner contribute real estate to a REIT’s operating partnership in exchange for OP units instead of cash. The transaction may defer capital gains recognition because the owner contributes property rather than selling it outright.
For most investors, the property that fits best is:
• Income-producing commercial real estate
• Appreciated investment property held for business or investment use
• Real estate a REIT considers desirable based on value, quality, market, and fit with its portfolio
• In some cases, property held through a DST that includes a 721 option after a holding period
Realized’s materials repeatedly describe Section 721 as a strategy for owners of commercial investment property, not personal-use real estate.
What usually does not qualify
Not every parcel of real estate is a realistic fit for a Section 721 exchange. A property may be ineligible, or simply unattractive to a REIT, if it falls outside the sponsor’s acquisition standards.
Common examples that generally do not work include:
• Personal residences
• Property held primarily for personal use
• Real estate a REIT does not want to acquire
• Assets that are too small, poorly positioned, or otherwise outside the REIT’s criteria
• REIT shares or OP units, because once you receive them, you no longer own real estate
That last point matters. After a completed 721 exchange, the investor holds OP units, which are securities interests in the operating partnership rather than direct ownership of real estate. That means they are not eligible for a future 1031 exchange.
REIT acceptance matters as much as property type
The practical test is not just whether the asset is “real estate.” The bigger question is whether a REIT is willing to take it.
Section 721 exchanges are not driven by broad like-kind rules the way 1031 exchanges are. Instead, the challenge is finding a REIT that wants the property. Realized notes that many investors will not have their property acquired because REITs tend to look for high-quality, investment-oriented assets that fit their portfolio strategy.
That is why eligibility is partly legal and partly market-driven. A property can be investment real estate and still not be accepted.
Can you use a 1031 or DST first?
Sometimes, yes. If your current property doesn't meet a REIT’s requirements, one approach is to complete a 1031 exchange into a replacement property that does, hold it for a period, and then pursue a 721 exchange.
Another possible route is a DST with a sponsor that offers a 721 option. After the required holding period, the sponsor may contribute the DST property into the UPREIT, and investors may receive OP units.
Key investor consideration
A Section 721 exchange can work best for owners of appreciated investment real estate who want to stop direct property management and move into a professionally managed structure. But eligibility depends on both the nature of the property and the REIT sponsor’s willingness to acquire it. Investors should review the REIT’s standards, lock-up terms, fees, and tax consequences with qualified advisors before moving forward.
Frequently Asked Questions
Does a rental property qualify for a Section 721 exchange?
A rental property may qualify if it is held for investment or business use and a REIT wants to acquire it through its operating partnership. Qualification is not automatic. The property still has to meet the sponsor’s underwriting, portfolio, and structural requirements.
Can I contribute my primary residence in a Section 721 exchange?
A primary residence generally is not the type of property used in a Section 721 exchange. These transactions are typically designed for investment or business-use real estate, especially appreciated commercial property that a REIT is willing to accept into its operating partnership.
Can I do a 1031 exchange after I complete a 721 exchange?
Generally, no. After a 721 exchange, you hold OP units rather than direct ownership in real estate. Because OP units are securities interests and not real property, they are not eligible for a future 1031 exchange into other investment real estate.
