The Difference between a 721 Exchange and a 1031 Exchange

Key Differences to keep in mind when considering both 721 Exchange and a 1031 Exchange:

Types of Assets Being Exchanged

In a 721 Exchange, an investor essentially converting their interests in a real estate property to operating partnership units (OP units) in the REIT. Investors must complete their 1031 exchange with like kind real estate. A 721 Exchange alone is not eligible for a 1031 Exchange because the REIT shares or OP units are not considered like kind real estate property. More on this distinction provided below.

Timeline

A 721 Exchange does not have to follow a set timeline. However, a DST to REIT program would generally have a “safe harbor” hold in the DST phase of approximately 2 years before the sponsor may exercise their right to call the DST property/ies into the REIT. Investors who are in the 1031 Exchange process must meet the 45th day to identify and 180th day to close on the replacement purchase deadlines. Get more details on the timeline.

721 Exchange

What is 1031/721 Exchange?

Learn more about 721 Exchange guidelines

Section 1031

Section 1031 allows a taxpayer to invest the proceeds from the sale of appreciated commercial real estate into “like-kind” property without recognizing a taxable gain. Most properties held for investment or use in a business qualify as “commercial real estate” under this definition.

1031 Securities (Delaware Statutory Trusts)

Delaware Statutory Trusts (DSTs) are trusts that may own income-generating, professionally managed commercial real estate. In 2004, the IRS issued Revenue Ruling 2004-86, which allows taxpayers to receive 1031 tax deferral treatment by investing the proceeds from the sale of their appreciated, commercial real estate into DSTs.

Section 721

A 721 exchange, also known as an UPREIT exchange, allows real estate investors to defer capital gains taxes by contributing property into a Real Estate Investment Trust’s (REIT) operating partnership in exchange for Operating Partnership Units (OP Units).

Comparison Chart

Both 1031 and 721 exchanges are reinvestment tax deferral strategies on real estate. There are key differences, listed above, to consider if they are right for you.

DST
Delaware Statutory Trust		 DST to UPREIT
721 Exchange
QUALIFIES FOR 1031? YES
See IRS Ruling 2004-86		 YES
See IRC Code 721
PROVIDES PROJECTED INCOME (Subject to performance) YES
Monthly approximately between 4%-5%		 YES
Usually quarterly, between 4% – 6%
INCOME TAX SHELTERED Substantially YES
If select moderately leveraged multifamily, senior housing, student housing (less so with industrial, commercial, hotel)		 Substantially YES
If initial selected DST has debt and increases your basis
LIKELY LIQUIDITY Unlikely before the DST asset sells in 5 to 10 years Highly likely to have good liquidity after a total of 3 years (2 years as a DST and an additional 1 year in the REIT) – subject to the terms of the sponsor’s share repurchase program
RISK SPECTRUM Lower risk on all cash assets, moderate risk on leveraged assets (we do not select highly leveraged assets for our clients) Risk can also be mitigated with multi-tenant assets, there could be higher risk with single tenant assets Lower risk spectrum on REIT as diversified portfolio, high quality core assets, leverage often less than 40%, income tends to be quite stable
FUTURE 1031 EXCHANGE AVAILABLE YES NO
PROS Defer capital gains, diversify into 2-10 assets, receive meaningful passive income, and possible income tax shelter from tax due to depreciation, and maintain future 1031 eligibility Defer capital gains, diversify into 100+ assets, receive meaningful income and possible shelter income from tax due to depreciation, and have liquidity
CONS Relatively illiquid – best to wait until the full DST sells rather than sell early, secondary market sales are possible but very limited, less diversification. 7 Deadly Sins of Rev 2004-86 General Real Estate market risks, etc. No continuation of 1031 exchange, general real estate market risks, etc., Possible limits on REIT’s share repurchase program, REIT share value may decline, loss of control, tax law changes

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UPREIT Guidance

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