Reducing Taxes Through 721 Exchanges: A Smart Exit for Real Estate Investors

Real estate investors looking to defer taxes and maintain growth potential often turn to 1031 exchanges. But what happens when the goal shifts from actively managing properties to transitioning into more passive investments without incurring a tax hit? That’s where the 721 Exchange comes in.

What Is a 721 Exchange?

A 721 Exchange, also called an UPREIT transaction, allows investors to contribute their interest in a Delaware Statutory Trust (DST) and then into a real estate investment trust (UPREIT). This move offers an efficient way to defer capital gains taxes while accessing the benefits of real estate ownership, without the responsibilities of day-to-day management.

Benefits of a 721 Exchange

The most compelling reason investors consider a 721 Exchange is tax deferral. Much like a 1031 exchange, it enables the investor to defer capital gains tax that would be due upon the sale of appreciated real estate. However, it also opens the door to:

• Liquidity Potential: Once the DST interest is converted to operating partnership units (OP Units) in an UPREIT, investors may gain access to future liquidity events, including potential conversion to REIT shares.
• Diversification: By exchanging into a REIT structure, investors can access a broader portfolio of professionally managed real estate assets.
• Estate Planning Flexibility: 721 Exchanges can help structure a smoother transition of wealth, potentially offering step-up in basis upon death for heirs.

How It Differs From a Traditional 1031 Exchange

While both strategies aim to defer taxes, 1031 exchanges require the investor to stay actively involved in real property ownership. In contrast, 721 Exchanges are typically the final step, turning an initial 1031 exchange into a long-term, passive investment vehicle through a DST and eventually a REIT.

Considerations Before Using a 721 Exchange

Not all DSTs are eligible for a 721 Exchange, and not all investors are a good fit. This strategy is typically suited for those looking to exit active property management, preserve wealth, and reduce estate complications. It’s important to consult with a financial advisor, tax professional, or real estate strategist to determine if this path aligns with your goals.

Loss of 1031 Eligibility Going Forward: Once your DST interest is converted into REIT shares through a 721 Exchange, you will no longer be eligible to complete future 1031 exchanges. REIT shares do not qualify as “like-kind” property under IRS rules. As such, the 721 is typically a permanent move—best suited for those who are ready to transition out of active real estate exchanges and into long-term, passive investing.

Is a 721 Exchange Right for You?

A 721 Exchange can be a powerful tool for tax deferral, income continuity, and long-term planning. If you’re evaluating your exit strategy from direct property ownership, this structure may provide the blend of tax efficiency and passive investing you’re looking for.

General Disclosure