Can You 1031 Exchange Into a REIT? Yes With a Twist
Real estate investors often ask whether they can complete a 1031 exchange directly into a REIT. The quick answer is no. Under IRS rules, REIT shares are considered personal property rather than real property, which disqualifies them from being like-kind replacement property.
That said, the door to REIT ownership is not closed. There is a well-established path that allows investors to move from a 1031 exchange into a REIT structure while preserving tax deferral. The strategy uses a Delaware Statutory Trust as the entry point and a 721 Exchange, also called an UPREIT contribution, as the bridge.
This combination offers investors the opportunity to transition from hands-on real estate ownership into a passive, diversified, professionally managed portfolio without triggering taxes along the way.
Why REIT Shares Don’t Qualify for a 1031 Exchange
A 1031 exchange allows an investor to sell investment property and reinvest the proceeds into another like-kind real estate asset. The IRS defines like-kind property broadly, but it must be actual real property.
REIT shares do not meet this standard because they are categorized as securities, not real estate. That means exchanging directly into a REIT would break the 1031 rules and result in an immediate tax bill.
This limitation is where the DST structure becomes especially valuable.
How the DST Solves the Problem
A Delaware Statutory Trust is a legal structure that holds title to real estate. The IRS recognizes beneficial interests in a DST as qualifying real property for a 1031 exchange. Investors can exchange into a DST the same way they would exchange into a building or a parcel of land.
Some DSTs are designed to serve as a transition step into a REIT. After meeting required holding periods and IRS guidelines, investors may be offered the option to contribute their DST interests to the REIT’s operating partnership through a 721 Exchange. In return, they receive OP Units, which behave similarly to REIT shares.
This approach gives investors access to REIT benefits while preserving the tax deferral originally created through the 1031 exchange.
How the Process Works
Step 1: Complete Your 1031 Exchange Into a DST
After selling your investment property, you reinvest the proceeds into a qualifying DST. Because DST interests count as like-kind property, your capital gains taxes remain deferred.
Step 2: Hold Your DST Interest
Most DSTs designed for an eventual 721 Exchange have a required holding period, often two years. During that time, investors receive passive income from the underlying properties.
Step 3: Execute the 721 Exchange Into a REIT
Once the holding period is met and the DST sponsor initiates the process, you may elect to contribute your DST interest to the REIT’s operating partnership. In exchange, you receive OP Units, which can later be converted into REIT shares.
This final step allows you to enjoy professional management, potential liquidity, and diversified exposure without losing the tax advantages gained through your 1031 exchange.
Why Investors Choose the DST-to-UPREIT Strategy
This pathway has become popular with investors transitioning out of active property management and into passive, long-term strategies. The reasons are straightforward.
Tax Deferral
You defer capital gains taxes when you move into a DST through a 1031 exchange, and the 721 Exchange extends that deferral into REIT ownership.
Passive Income
No more landlord responsibilities. Both DSTs and REITs generate passive income, allowing investors to enjoy consistent cash flow.
Estate Planning Advantages
Heirs often receive a step-up in basis on OP Units or REIT shares, which can eliminate the original deferred taxes entirely.
Access to Liquidity
REIT shares generally offer more liquidity than real estate or DST interests. While OP Units must follow holding and conversion rules, they ultimately provide an option for liquidity that property ownership typically lacks.
Choosing the Right DST Matters
Not every DST is eligible or intended for a future 721 Exchange. Investors who want the option to transition into a REIT should choose a DST specifically structured for this purpose.
What to Look For in a 721-Compatible DST
721 Compatibility
Confirm that the DST is intended for an eventual UPREIT contribution and that this structure is disclosed clearly.
Sponsor Transparency
The sponsor should outline expectations, timing, process steps, and any conditions required for the 721 Exchange.
Track Record
Choose sponsors with experience in successful DST-to-UPREIT transitions and a strong history of investor support.
Final Thoughts: The Bridge That Makes REIT Ownership Possible
While the IRS does not permit a direct 1031 exchange into a REIT, the DST-to-UPREIT strategy offers an elegant solution. It allows investors to step away from active management, maintain tax deferral, and eventually participate in the benefits of REIT ownership.
For those seeking diversification, estate-friendly structures, and potential liquidity, this approach creates a clear path into a professionally managed portfolio without losing the advantages of a 1031 exchange.
If you would like help evaluating DST or UPREIT options, our team can walk you through the process and determine whether a 721-compatible DST fits your financial strategy.
