721 Exchange Pros and Cons: Benefits, Risks and Who It Fits

Key takeaways

• A 721 exchange lets you contribute property to a partnership for units without paying tax on the gain at that moment. In real estate, the partnership is usually a REIT's operating partnership.
• The main pros are continued tax deferral and a slice of a large, spread-out portfolio. Units can also be cashed out in pieces over time and divided easily among heirs.
• The biggest con is the "one-way door": units can't go into another 1031 exchange. Others include lock-ups, redemption limits, one REIT manager, REIT fees, interest-rate risk and tax events you don't control.
• Cashing out units, or swapping them for REIT shares, is generally taxable. Under current law, holding units until death is the path that may avoid the deferred tax for good.
• A 721 tends to fit investors who are done exchanging real estate, have other liquid savings, and care about passing on a divisible asset. It tends to fit poorly if you may want another 1031 or need your money back by a set date.
• In my offering records as of October 2026, 44 offerings (58%) make the 721 exit optional and 17 (22%) have none. You can choose DSTs with an optional 721 exit or none at all.

Why does a 721 exchange come with trade-offs?

Before we weigh the pros and cons, let me define the pieces. Each term matters for what comes next.

Start with the 1031 exchange. When you sell investment real estate and roll the money into more investment real estate under Section 1031, the capital gains tax waits. That waiting is called tax deferral.

Now the 721 exchange. It's named for Section 721, which says that "No gain or loss shall be recognized" when someone contributes property to a partnership for an interest in it. Put simply, you hand over property, you get a partnership stake back, and the hand-off itself isn't taxed.

The partnership in question usually belongs to a REIT, or real estate investment trust. A REIT is a company built to own rental property, often hundreds of buildings at once. Its shares may be listed on an exchange, or they may be non-traded, meaning they aren't listed anywhere.

Most REITs use an UPREIT structure, short for "umbrella partnership REIT." The REIT holds its buildings through a partnership called the operating partnership, or OP. A 721 exchange makes you a partner in that OP. Your stake comes as OP units, and each unit is typically built to track one REIT share in value and in distributions.

For most individual investors, the road to units runs through a Delaware Statutory Trust, or DST. A DST is a trust that holds real estate on behalf of many investors at once. A DST interest can qualify as replacement property in a 1031 exchange. In a "721 DST," the REIT's OP holds an option to acquire the trust's property later and pay for it with units. My DST guide covers the basics of DSTs.

So why are there trade-offs at all? Because you're changing what you own. Before the 721, you own real estate, or a share of a trust that owns real estate. After it, you own a partnership interest in a company. That change opens some doors and closes others. My main 721 exchange guide walks through the mechanics step by step. This page focuses on whether the trade is worth it.

What are the pros and cons of a 721 exchange at a glance?

Here's the short version. Each row gets its own section below.

Notice how many pros come paired with a con. Partial liquidity is a real benefit, but it runs on the REIT's terms. Professional management is a real benefit, but it means giving up control. That pairing is the heart of the decision.

What are the advantages of a 721 exchange?

1. Your tax deferral continues

The core benefit is the one in the statute. Contributing property to a partnership for units is generally not a taxable event. Basis means your tax cost. When you sell, your taxable gain is about what you receive minus that cost. Under Section 722, your basis in the units equals "the adjusted basis of such property" you contributed.

So your old, low basis moves into the units. The gain you deferred through earlier 1031 exchanges stays deferred. Your holding period can carry over too, under Section 1223, so the units can count as long-term from the start.

Deferral isn't forgiveness. The tax still comes due if you later cash out. But keeping your full equity at work, instead of paying a large tax bill now, is often the main reason people consider this path.

2. Diversification inside one investment

A DST usually owns one property or a small group. A REIT's operating partnership may own dozens or hundreds of buildings across many markets and tenants. When your DST converts to units, your money is spread across that whole portfolio.

That can reduce the risk tied to any single building, tenant or city. If one property loses its main tenant, it's a smaller part of what you own.

This benefit has limits, though. You're spread across many buildings, but they're all run by one company. I'll come back to that in the cons.

3. You can cash out in pieces

With a building or a DST interest, you generally can't sell part of it when you want. You wait for the whole property to sell.

OP units work differently. After a holding period, you can usually ask the OP to redeem some of your units. The REIT then decides whether to pay you cash or issue REIT shares. You can take, say, 10% of your units one year and 10% the next.

That makes it easier to match cash to your needs. It also lets you spread your taxable gain across several years. Smaller yearly slices of gain may face lower rates than one large year. My guide to operating partnership units works through that math in detail.

4. No deadlines at the contribution

A 1031 exchange runs on a tight clock. Replacement property must be identified in writing within 45 days of the sale. The purchase must close within 180 days or your tax return due date (with extensions) for the year of the sale, whichever comes first. You also need a qualified intermediary, or QI, the company that holds your sale money so you never touch it.

The contribution to the OP skips all of that. Nothing has to be identified, nothing has to close by a deadline, and no QI or like-kind test is involved. If you reach units through a DST, you still meet the 1031 deadlines when you buy the DST interest. But the later conversion runs on its own schedule.

5. No landlord duties

Owning units is passive. You don't collect rent, approve repairs, refinance loans or sign leases. The REIT's management team handles all of it.

For an owner who has spent decades managing rentals, that's a big change. A DST is already passive. Units go one step further, because you no longer track a specific building at all.

6. Easier to split among heirs

Units are easy to divide. If you hold 60,000 units and have three children, each child can inherit 20,000. Then each one can make his or her own choice. One can redeem, one can convert to REIT shares and one can keep holding.

Compare that with a building. Heirs who inherit one property together have to agree on every decision. That can strain a family.

7. A possible reset of the gain at death

Inherited property generally starts over with a new basis. Section 1014 sets it at "the fair market value of the property at the date of the decedent's death," and under current law OP units are covered.

So if you hold units until death, your heirs' basis resets to the units' value. If they redeem soon after, they may owe little or no tax on the gain you deferred for decades. My guide to 721 exchange estate planning covers this in depth, including how heirs pay any estate tax when units are hard to sell.

Congress can change this rule. Treat it as current law, not a permanent feature.

8. Some flexibility to convert to shares

If the REIT is listed on a stock exchange, the shares you get on redemption can be sold on any market day. That's much more flexible than a DST interest. If the REIT is non-traded, share liquidity is more limited, as the cons explain.

What are the disadvantages and risks of a 721 exchange?

Now the other side. Most of these cons are permanent once you hold units, which is why they deserve the most attention.

1. The one-way door: no more 1031 exchanges

This is the big one. Section 1031 applies only to the "exchange of real property." OP units are partnership interests, and REIT shares are stock. Neither is real property. So once you hold units, you can't defer gain with another 1031 exchange.

Here's why that matters. Picture a 62-year-old who might trade properties a few more times before retiring. Each of those future exchanges could defer tax again. A 721 ends that chain. The next time you want out, the tax on all your deferred gain, from every property you've ever exchanged, comes due.

People call this the "one-way door." You can walk through it easily. You can't walk back.

2. Lock-ups and redemption limits

A lock-up is a period when you can't redeem your units. Partnership agreements can require you to hold units for a set period after they're issued, such as a year or more. Terms vary, so read the operating partnership agreement.

After the lock-up, redemption still isn't on demand. The REIT chooses whether to pay cash or shares. In a non-traded REIT, getting cash for shares runs through a share redemption program, a plan in which the REIT buys back shares from investors.

The SEC's investor bulletin on non-traded REITs says these programs "are typically subject to significant limitations." It also says they "may be discontinued at the discretion of the REIT without notice." Some "may require that shares be redeemed at a discount."

In plain words, if many investors ask for their money at once, you may get only part of your request, or none of it, for a while. If you need cash by a set date, that's a real problem.

3. You depend on one REIT and one manager

Diversification across buildings doesn't mean diversification across managers. Every unit you hold depends on one company's strategy, balance sheet, fees and decisions.

Investor.gov notes that "Non-traded REITs typically have an external manager instead of their own employees." An external manager is a separate company paid to run the REIT. That arrangement can create conflicts of interest, because the manager's fees may grow as the REIT grows.

If you might have split your exchange across three DSTs from three sponsors, a 721 can turn that into one exposure. That's concentration, even if the portfolio is large.

4. REIT underperformance

A REIT can do worse than the property you contributed. It might buy assets at high prices, take on more debt, cut distributions or own property types that fall out of favor. Your units rise and fall with the whole portfolio, not your old building.

Distributions can also be paid from sources other than operating income. The SEC bulletin warns that "Non-traded REITs may use offering proceeds, which includes the money you invested, and borrowings to pay distributions." It adds that "This practice reduces the value of the shares."

Distributions from a REIT, and from its OP, are not guaranteed. They can be reduced or stopped.

5. Sensitivity to interest rates

FINRA's investor guide to REITs says "Changes to interest rates, property values and the economy may also affect the returns of REIT investments." It also notes that publicly traded REITs "tend to be more liquid but also more prone to price swings."

Here's why rates matter, in plain English. Real estate investors price property using a cap rate, short for capitalization rate. It's a building's yearly net operating income divided by its price. When interest rates rise, buyers usually demand higher cap rates, because they can earn more elsewhere and borrowing costs more.

Take a hypothetical portfolio with $1,000,000 of yearly net operating income. At a 5% cap rate, it's worth $20,000,000. At a 6% cap rate, the same income supports a value of about $16,670,000. That's a drop of about 17%, with no change in rent.

Rates hit REITs in two more ways. Higher rates raise the cost of any floating-rate or maturing debt, which can squeeze cash flow. And income investors may compare REIT distributions with bond yields, which can move listed REIT prices. A non-traded REIT's value usually changes more slowly, because it's based on appraisals. Slower doesn't mean protected. It can mean the drop shows up later.

6. Taxable exits

The deferral lasts only as long as you hold. Redeeming units for cash is generally a taxable event. Depending on how the redemption is set up, it may be treated as a sale of units to the REIT or as a cash distribution from the partnership, and the tax math differs. Swapping units for REIT shares is generally a taxable exchange too, even though you receive no cash.

Under Section 1001, your gain on a sale or exchange is "the excess of the amount realized therefrom over the adjusted basis." With units, the debt you're freed from counts as money you received under Section 752, so it adds to the amount realized along with any cash or shares. People who forget that piece underestimate their tax.

Part of the gain can be taxed at up to 25% because of past depreciation. Depreciation is the yearly tax deduction for wear and tear on a building. The IRS says that portion of real estate gain is "taxed at a maximum 25% rate." The rest is generally long-term capital gain, taxed at up to 20%. The net investment income tax, a 3.8% federal tax on investment income above certain income levels, can also apply under Section 1411.

7. Tax events you don't control

You can owe tax even if you never redeem a unit. Three things can cause it.

• The OP sells your property. When you contribute, the gap between your property's value and its tax basis is your built-in gain. Section 704(c) makes the partnership track that gap and assign it to the partner who brought it. So a sale of your old property by the OP generally sends that gain to your tax return.
• Your share of debt drops. Under Section 752, "Any decrease in a partner's share of the liabilities" counts as cash paid to you. If that deemed cash is more than your basis, the extra is taxable gain under Section 731.
• The REIT merges or is bought. Depending on the deal, unitholders might keep units in the combined company or receive cash. Receiving cash can make the deferred gain taxable.

Large contributors sometimes negotiate a tax protection agreement, a contract in which the REIT agrees to cover some of that tax. Assume you don't have one unless the offering documents say so.

8. You don't choose the timing, and you don't set the price

In a 721 DST, the option to convert belongs to the operating partnership. You can't force the 721 to happen, and it may never happen. If the exit is mandatory, you can't refuse it when the OP acts.

Value at conversion comes from an appraisal arranged on the sponsor's side, and the buyer is typically a REIT affiliated with that sponsor. Programs may use independent appraisers, but it isn't an open-market sale. If property values have fallen since you invested, you receive fewer units.

9. A disguised sale if you cash out too soon

The tax code has rules that can treat a contribution plus a quick payout as a sale. Treasury Regulation §1.707-3 sets a two-year window. When a contribution and a payment back to the partner fall inside it, "the transfers are presumed to be a sale of the property to the partnership." The facts would have to clearly show otherwise to overcome that. Regular distributions from operating cash flow are treated differently. Under Treasury Regulation §1.707-4, an operating cash flow distribution "is presumed not to be part of a sale" unless the facts clearly show otherwise. So a 721 is built for a long hold, not a quick exit.

10. Fees and paperwork

As a unitholder, you share in the REIT's costs every year. Those can include advisory or management fees, possible performance fees and property-level costs. When non-traded REIT shares are sold to investors, Investor.gov warns that they "generally have high up-front fees." Units issued in a 721 may not carry the same sales charges, but the ongoing fees still reduce your returns. Get the REIT's fee table while you're still choosing a DST.

Paperwork changes too. As a partner, you get a Schedule K-1, the tax form a partnership sends each partner showing their share of income and deductions. The IRS says "The partnership uses Schedule K-1 to report your share of the partnership's income, deductions, credits, etc." K-1s often arrive later than 1099s (the forms that report investment income), and a large OP may create state filing duties in places you've never been.

11. Tax-law risk

Everything on this page reflects current law. That includes the basis reset at death, the rates above and the rules for partnerships. Any of it can change. A plan that only works if today's law lasts 30 more years is fragile.

Common myths about 721 exchanges

Several ideas about 721 exchanges are only half right. Here are the ones that cause the most trouble.

Myth: "A 721 eliminates my tax"

It doesn't. A 721 defers tax. Your deferred gain stays attached to your units. It comes due when you redeem, convert to shares, or when the OP sells your property. The only route that may avoid it for good under current law is holding until death.

Myth: "OP units are just REIT shares"

They pay the same distribution per unit as one share, but they're taxed very differently. Units carry your old basis, your built-in gain and a share of partnership debt. Shares don't. Units come with a K-1. Shares come with a 1099-DIV, the form a company sends shareholders to report dividends.

Myth: "I can choose when my DST converts"

In DST-to-721 programs, the operating partnership typically holds the option. It decides whether and when to use it. You decide only whether to buy a 721 DST in the first place, and, in some optional programs, whether to accept units when the option is used.

Myth: "Units are liquid, like stock"

Units are more liquid than a DST interest, which usually can't be sold until the property sells. They're much less liquid than a listed stock. Lock-ups, the REIT's choice of cash or shares, and redemption limits all stand between you and your money.

Myth: "A 721 has the same deadlines as a 1031"

The 721 contribution has no 45-day or 180-day deadline and needs no QI. Those rules apply when you buy the DST interest with your 1031 money. People mix the two up often, which can lead to rushed or mistaken decisions.

Myth: "The REIT will always pay a fair price"

An appraisal sets the conversion value, and the buyer is typically a REIT affiliated with the sponsor. That's a conflict of interest worth understanding. It doesn't mean the price is unfair. It means you didn't negotiate it.

A worked example: four paths for the same exchange

Everything in this example is hypothetical. The round numbers don't come from any offering or any client, and they aren't typical of any offering. Treat it as an illustration, not tax advice.

The setup

Say you're 64. You sold a rental through a 1031 exchange and put $1,500,000 of equity into a DST. Your deferred gain is $1,000,000. Of that, $300,000 comes from past depreciation. To keep it simple, assume the DST has no debt, no OP debt is assigned to you later, values stay flat, and you're in the top federal brackets.

If that whole gain were taxed in one year, the federal bill would look like this:

• Depreciation portion: $300,000 × 25% = $75,000
• Remaining long-term gain: $700,000 × 20% = $140,000
• Net investment income tax: $1,000,000 × 3.8% = $38,000
• Federal total: $253,000, before any state tax

Path A: A DST with no 721 exit

The DST sells its property in year 10 and returns your equity. You do another 1031 exchange into new real estate. Your $1,000,000 gain stays deferred, and you keep all $1,500,000 working. You can repeat this at each sale, as long as you follow the 1031 rules each time.

The cost: you're back to choosing replacement property, meeting deadlines and accepting the illiquidity of each new investment.

Path B: A 721, then you want to move the money

The OP uses its option in year 3, and you receive units. In year 10, at age 74, you want your money in something else. Maybe you want to buy a property near your children, or move into a different investment.

You can't 1031 out of units. You redeem them all and, in this simplified example, owe about $253,000 in federal tax. Actual treatment depends on how the redemption is set up. You have about $1,247,000 left to reinvest. That's the one-way door in dollars.

Path C: A 721, held until death

Same conversion in year 3. This time you hold the units for life and take distributions, which are not guaranteed. You die at 88. Under current law, your heirs' basis resets to the units' value at your death. If they redeem soon after, they may owe little or no tax on your $1,000,000 of deferred gain.

Path D: A 721, redeemed in slices

Say you need extra income starting at 75. You redeem one-tenth of your units each year for 10 years. In this simplified example, each slice triggers about one-tenth of the gain. How much gain a real redemption triggers depends on how it's set up and on your share of the partnership's debt. Ten smaller years of gain may face lower rates, and less of the 3.8% tax, than one very large year.

What the example shows

The 721 works well in Paths C and D. It works poorly in Path B. So the most important question isn't "Is a 721 good?" It's "Am I likely to end up on Path B?"

How can falling values change the math?

The example above assumes flat values. Real values move, and debt makes the moves bigger. This second hypothetical shows why that matters at conversion.

Say you invested $1,000,000 of equity in a DST with 50% loan-to-value, or LTV. LTV is the loan divided by the property's value. So your share of the property is $2,000,000, and your share of the debt is $1,000,000.

At conversion, the appraisal comes in 10% lower than your purchase price. Your share of the property is now $1,800,000. The debt is still $1,000,000. Your equity is $800,000, down 20%.

If each unit is valued at $25, you receive 32,000 units. Had values held, you'd have received 40,000. Leverage turned a 10% drop in property value into a 20% drop in your equity. The tax deferral didn't change that at all.

That's why the tax feature alone is never a good enough reason to pick a 721 program. The investment has to make sense first.

Who should consider a 721 exchange, and who should pass?

These profiles are general and hypothetical. They aren't recommendations, and your own facts may differ.

Profiles where a 721 can make sense

• The retiree who is done exchanging. You're in your 70s, you don't plan to buy real estate again, and you want income without landlord duties. Losing future 1031s costs you little.
• The estate-focused owner. You plan to hold until death and want to leave several heirs something easy to divide. The basis reset at death, under current law, is a key part of your plan.
• The owner who wants gradual liquidity. You'd like the option to cash out in pieces over several years, and you accept that it's limited, not on demand.
• The investor with plenty of other savings. Your cash and other liquid assets can cover surprises, so units never have to be sold in a weak year.
• The investor who splits the exchange. You put part of your equity in a 721 DST and the rest in DSTs without a 721 exit. If you're unsure, splitting keeps some money exchangeable.

Profiles where a 721 usually doesn't fit

• The active exchanger. You're in your 50s or early 60s and may want to sell and exchange again in five or ten years. Units would end that option.
• The investor with a date-certain need. You'll need a large sum for a home, a business or a family need by a set date. Redemption timing isn't yours to control.
• The investor with most of their net worth in one exchange. Putting most of your wealth behind a single REIT manager, with a single way out, is heavy concentration.
• The hands-on owner. You want to know exactly which building you own and have a say in how it's run.
• The investor who isn't accredited. Most DSTs, including 721 DSTs, are sold only to accredited investors, people who meet SEC income, net worth or license tests. My guide on accredited investor status explains the tests.

How to weigh the pros and cons of a 721 exchange, step by step

Step 1: Write down your time horizon

How long do you expect to hold this money? Do you expect to sell and exchange real estate again? If the honest answer is "maybe," treat that as a reason for caution.

Step 2: Run the one-way-door test

Ask your CPA what tax you'd owe if you had to redeem all your units in year 10. Then ask whether you could live with that outcome. If not, think about sending just a portion of your exchange money down the 721 route.

Step 3: Read the exit terms in the DST documents

Every DST is sold through a private placement memorandum, or PPM, the legal document that describes the deal and its risks. Find the section on the 721 exit. Is it optional or mandatory? Who decides, and how is value set? What happens if the option is never used?

Step 4: Read the REIT's documents too

Once you hold units, your rights come from the OP's partnership agreement, plus the REIT's prospectus (the offering document a REIT files with the SEC when it sells shares to the public) or annual report. Check the lock-up period, redemption terms, fees and the REIT's debt levels. For a non-traded REIT, learn how its redemption program works and whether it has been limited before. My guide to non-traded REITs explains these programs.

Step 5: Ask how debt will be handled

If your basis is low and the DST uses debt, ask how the OP assigns its debt to people coming in from DST programs. A large drop in your share of debt at conversion can create taxable gain.

Step 6: Stress-test the investment

Ask what happens to your units if property values fall 10% or 20% before conversion, or if interest rates rise. Ask how distributions have been funded. Ask what fees you'll pay as a unitholder.

Step 7: Plan your liquidity outside the units

Keep enough liquid savings that you won't need to redeem in a bad year. Units should be money you can leave alone.

Step 8: Confirm with your CPA, attorney and QI

Bring your CPA, estate attorney and qualified intermediary in before you buy the DST. A 721 is as much a tax and estate decision as an investment one. My guide comparing a 721 exchange vs. a 1031 exchange can help you frame that conversation.

Mistakes to avoid when weighing a 721 exchange

1. Buying a 721 DST without noticing. Many DSTs now include a 721 feature. Read the exit section of every PPM before you invest, so you know which kind you're buying.
2. Assuming the 721 will happen. The OP has an option, not a duty. Plan as if you may stay in the DST for its full hold, or longer.
3. Choosing a mandatory program when you're unsure. If you may want another 1031 exchange, a mandatory 721 exit removes your choice.
4. Putting all your equity on one 721 path. Splitting between a 721 DST and DSTs without one keeps part of your money exchangeable.
5. Ignoring the REIT behind the DST. The DST is temporary. The REIT is what you'll own long term. Study its strategy, debt, fees and redemption history.
6. Treating the quoted value per unit as a market price. Non-traded REITs publish a net asset value, or NAV, which is an appraisal-based estimate of their holdings minus debts. No buyer is obliged to pay you that figure.
7. Counting on liquidity for a set date. Redemption limits can delay your cash. Don't plan a home purchase or a business deal around redeeming units by a certain month.
8. Forgetting that cashing out is taxable. Redemption and conversion to shares both trigger gain, including on the debt you're freed from.
9. Redeeming too soon. Money from the partnership within two years of the contribution, other than regular operating distributions, can be presumed a disguised sale.
10. Redeeming everything in one year. One large redemption can push gain into higher brackets and raise the 3.8% tax.
11. Not updating your estate plan. Units usually need the consent of the general partner, the partner that runs the partnership (usually the REIT itself), to transfer. Make sure your trust and beneficiary plans fit what the partnership agreement allows.

How I look at 721 programs

My real estate career includes acquisitions, management and development work at ValueRock Realty Partners, Faris Lee Investments, Westport Capital Partners and Arbor Bay Capital Partners, and my background page has more.

Every DST we consider, 721 programs included, goes through five areas of due diligence: broker-dealer review, investment manager audit, investment offering review, real estate assessment and institutional underwriting. We partner with outside auditors in each area, and the review is ongoing, not a one-time check. Our platform includes DSTs from more than 20 institutional sponsors, and we track more than 1,100 full-cycle 1031 DST investments for performance.

If we talk, we'll go through the offerings I currently have available together. For each one, I'll tell you why it's on my list, what I like and where I have reservations, including whether its 721 feature suits you. Securities are offered through Aurora Securities, Inc., member FINRA/SIPC. Baker 1031 Investments is independent of Aurora.

What my data shows

My offering records as of October 2026 cover 76 DST offerings from 38 sponsors. The numbers below describe that set of offerings only. They don't predict what any future offering will do.

17% of offerings make the 721 exit mandatory

The number that matters most for this page: 13 offerings (17%) in my offering records as of October 2026 make the 721 exit mandatory. In those programs, your DST interest converts to units if the operating partnership uses its option. You'd then face every con on this page, whether or not you planned for it.

The other side is just as useful. 44 offerings (58%) make the exit optional, and 17 (22%) have no 721 exit at all. So if the one-way door worries you, you aren't stuck. You can choose DSTs without a 721 feature, or optional ones, and keep your 1031 path open.

Low minimums make splitting easier

In my offering records as of October 2026, the median minimum investment is $100,000. The range runs from $25,000 to $500,000, and 21 offerings (28%) accept $25,000. Small minimums let you divide one exchange between a 721 DST and DSTs with no 721 feature. That's one of the simplest ways to get some of the pros while limiting the cons.

Debt affects the conversion risk

Here's how leverage breaks down in my offering records as of October 2026:

With no loan at the DST level, an all-cash program removes one source of tax risk at conversion. A leveraged program can help you replace the debt you paid off in your 1031, but it amplifies any change in value before conversion. Which suits you comes down to your own basis and goals.

Holds and the timing of the option

In my offering records as of October 2026, the most common projected hold is 10 years, at 31 offerings. Others project 5 to 10 years or 7 years, and a few are 2-year programs. For a 721 DST, the projected hold is only a guide: the OP may use its option early, late or never.

Frequently asked questions

What are the main pros and cons of a 721 exchange?

The main pros are continued tax deferral, diversification across a large REIT portfolio, the ability to cash out in pieces, and units that are easy to split among heirs. The main cons are losing future 1031 exchanges, lock-ups and redemption limits, REIT fees, dependence on one manager and taxable exits.

What is the biggest downside of a 721 exchange?

For most investors, it's the one-way door. OP units and REIT shares aren't real property, so you can't defer gain with another 1031 exchange once you hold them. When you eventually cash out during your life, the deferred tax comes due.

How long are OP units usually locked up?

Lock-up terms vary by partnership agreement, and some last a year or more after units are issued. Even after that, the REIT chooses whether to pay cash or shares, and non-traded REIT redemption programs can be limited.

Can a REIT stop redemptions after my 721 exchange?

In a non-traded REIT, yes. The SEC says share redemption programs "may be discontinued at the discretion of the REIT without notice." Plan as if your cash could take longer to reach you than you'd like.

How do interest rates affect a 721 exchange?

Higher rates can lower property values, raise a REIT's borrowing costs and pressure distributions. That can reduce the number of units you receive at conversion and the value of units you already hold. Listed REIT prices can react quickly, while non-traded REIT values may adjust more slowly through appraisals.

Who should not do a 721 exchange?

A 721 usually fits poorly if you may want another 1031 exchange, need a large sum by a set date, or have most of your net worth in this one investment. It also isn't open to most non-accredited investors, because 721 DSTs are typically private placements.

Is a 721 exchange worth it for retirees?

It can be for retirees who are done exchanging, want passive income and care about leaving heirs a divisible asset. Distributions are not guaranteed, though, and cashing out during life is taxable, so keep other savings for emergencies.

Can my OP units lose value?

Yes. Units rise and fall with the REIT's portfolio, and you can lose some or all of your investment. If values fall before conversion, you also receive fewer units.

Can I refuse the 721 conversion?

Only if the program allows it. With a mandatory exit, the conversion happens whenever the OP acts, while some optional programs let you decline units. Check the PPM's exit section before you invest.

Do 721 exchanges cost more in fees than DSTs?

They add a layer, because once you hold units you pay the REIT's ongoing advisory, management and property-level costs. Compare the REIT's fee table with the DST's fees before you buy, since you can't change programs after the option is used.

Before you act

I wrote this page to educate, not to give tax, legal or investment advice. Before you choose a 721 program, check your plan with your CPA, attorney and qualified intermediary. DSTs are sold only through a private placement memorandum, usually to accredited investors only. They're illiquid and give you limited control, distributions are not guaranteed, and you could lose everything you invest.

Sources

• 26 U.S.C. § 721, Nonrecognition of gain or loss on contribution (Cornell LII)
• 26 U.S.C. § 722, Basis of contributing partner's interest (Cornell LII)
• 26 U.S.C. § 1223, Holding period of property (Cornell LII)
• 26 U.S.C. § 1014, Basis of property acquired from a decedent (Cornell LII)
• 26 U.S.C. § 1031, Exchange of real property held for productive use or investment (Cornell LII)
• 26 U.S.C. § 1001, Determination of amount of and recognition of gain or loss (Cornell LII)
• 26 U.S.C. § 1411, Net investment income tax (Cornell LII)
• 26 U.S.C. § 704, Partner's distributive share (Cornell LII)
• 26 U.S.C. § 752, Treatment of certain liabilities (Cornell LII)
• 26 U.S.C. § 731, Extent of recognition of gain or loss on distribution (Cornell LII)
• 26 CFR § 1.707-3, Disguised sales of property to partnership (Cornell LII)
• 26 CFR § 1.707-4, Disguised sales: operating cash flow distributions (Cornell LII)
• IRS Topic No. 409, Capital gains and losses
• IRS, Partner's Instructions for Schedule K-1 (Form 1065)
• SEC / Investor.gov, Investor Bulletin: Non-traded REITs
• Investor.gov, Real Estate Investment Trusts (REITs)
• FINRA, Real Estate Investment Trusts: Alternatives to Ownership