The Foundation of UPREIT Strategies: 721 Exchanges Explained
Investors who have spent years building wealth through real estate often look for ways to keep growing while reducing the burdens of management and taxation. Among the available tools, the 721 Exchange has become a central strategy for moving from direct ownership into a more diversified, professionally managed structure through an UPREIT. Understanding how a 721 Exchange works—and how it pairs with a 1031 Exchange—can help investors build a more flexible, long-term plan for their holdings.
What Is a 721 Exchange?
A 721 Exchange, sometimes called an UPREIT Exchange, allows a property owner to contribute real estate interests to a REIT’s operating partnership in exchange for Operating Partnership Units, or OP Units. Instead of selling the property and paying capital gains taxes, the owner transfers it to the operating partnership and receives equity in the broader portfolio.
Because the contribution is treated as a tax-deferred event, the investor avoids recognizing capital gains at the time of the exchange. In return, the investor shifts from owning and managing a single property to holding an interest in a larger, professionally managed collection of assets.
How a 721 Exchange Works
Although each transaction contains its own technical elements, the basic structure of a 721 Exchange follows a clear sequence.
Contributing Property to the Operating Partnership
The owner transfers their property to the REIT’s operating partnership. In exchange, the operating partnership issues OP Units that represent the investor’s proportional interest in the portfolio.
Deferral of Capital Gains Taxes
Because the transaction is structured as a contribution rather than a sale, capital gains taxes that would otherwise be owed are deferred. The full value of the property continues working inside the REIT structure.
Receiving OP Units
The OP Units represent the investor’s ownership position in the operating partnership. These units track the portfolio’s performance and provide access to income distributions.
Potential Conversion to REIT Shares
Over time, OP Units may be eligible for conversion into REIT shares. This provides an eventual path to liquidity and allows investors to benefit from the operational and market advantages of the REIT.
The Role of OP Units in the Strategy
OP Units sit at the core of a 721 Exchange and serve as the bridge between direct property ownership and participation in a REIT. Their benefits typically include:
Passive Income
OP Unit holders receive distributions tied to the REIT’s income, allowing them to enjoy ongoing cash flow without managing tenants, leases, or maintenance.
Liquidity Options
Although OP Units are not immediately liquid, they may convert into REIT shares after holding period requirements are met. This provides more optionality than traditional real estate ownership.
Diversification
By owning OP Units, investors gain exposure to the REIT’s full portfolio rather than relying on the performance of a single property.
Advantages of a 721 Exchange
The 721 structure appeals to investors who want to simplify their real estate investments while maintaining tax efficiency and long-term growth potential.
Tax Deferral
Because a sale does not occur, capital gains taxes are deferred. Investors keep more equity invested and working for them.
Reduced Management Responsibilities
Once the property is contributed, the REIT assumes all operational responsibilities. Investors transition to a passive role.
Improved Liquidity
OP Units and subsequent REIT shares allow for liquidity options unavailable in traditional real estate, making long-term planning easier.
Portfolio Diversification
The REIT’s portfolio typically covers multiple property types and geographies, reducing concentration risk.
Estate Planning Efficiency
OP Units can be incorporated into estate strategies with greater simplicity, and heirs often benefit from a step-up in basis.
Integrating 1031 Exchanges with 721 Exchanges
Many investors use a two-step approach by combining a 1031 Exchange with a later 721 Exchange.
Step 1: Begin with a 1031 Exchange
The investor sells appreciated real estate and reinvests the proceeds into a like-kind property without triggering capital gains taxes. For many, this step involves moving into a DST to achieve passive income while preserving tax deferral.
Step 2: Transition to a 721 Exchange
After the appropriate holding period, the DST interests or replacement property can be contributed to a REIT’s operating partnership through a 721 Exchange. The investor then receives OP Units and gains access to the REIT structure.
Step 3: Benefit from Both Structures
This combined strategy allows an investor to defer taxes through the 1031 exchange and later enter a diversified REIT portfolio via a 721 contribution. It is a powerful way to move from active ownership into a long-term, passive structure without losing the tax advantages built over years of investment.
Is a 721 Exchange the Right Fit?
A 721 Exchange is commonly used by investors who:
• Own appreciated real estate
• Want passive income instead of property management
• Seek diversification beyond a single asset
• Want liquidity options not available in direct ownership
• Are planning for estate transitions and generational wealth
If these goals align with your long-term strategy, a 721 Exchange may offer a smooth transition into a more flexible and professionally managed investment structure.
Final Thoughts
The 721 Exchange provides a powerful way for investors to scale, simplify, and modernize their real estate portfolios. When paired with a 1031 Exchange, it creates a strategic path for long-term tax efficiency, diversification, and wealth preservation.
For investors considering how to position their real estate holdings for the future, understanding how these tools work together is essential. With thoughtful planning and expert guidance, the 721 Exchange can become the foundation for a lasting and flexible investment strategy.
