1031 vs. 721 Exchanges: Strategies for Real Estate Exit Planning

For real estate investors, building wealth through property ownership often comes with the eventual question: How do I exit efficiently while preserving the equity I’ve built and minimizing taxes? Two of the most powerful tools available are 1031 exchanges and 721 exchanges, often used in conjunction with Delaware Statutory Trusts (DSTs). 

Understanding when and how to use each strategy can make a significant difference in your long-term financial plan.

What Is a 1031 Exchange?

A 1031 exchange, named after Section 1031 of the Internal Revenue Code, allows you to defer capital gains taxes when you sell an investment property—as long as you reinvest the proceeds into another “like-kind” property.

Key Features of a 1031 Exchange:

• Tax deferral on capital gains, depreciation recapture, and state taxes.
• You must identify a replacement property within 45 days and close within 180 days.
• The exchange must be executed through a qualified intermediary.
• The replacement property must be of equal or greater value and involve no “boot” (taxable gain).

When to Use a 1031 Exchange:

• You want to stay active in real estate investing.
• You’re looking to diversify or consolidate property holdings.
• You’re aiming to exchange into passive real estate (e.g., a DST).

What Is a 721 Exchange?

A 721 exchange, often called an UPREIT (Umbrella Partnership Real Estate Investment Trust), allows an investor to contribute real property to a REIT in exchange for Operating Partnership (OP) units, which are generally not taxed at the time of exchange.

Key Features of a 721 Exchange:

• The exchange must involve a REIT-sponsored Operating Partnership.
• You receive OP units, which can later be converted into publicly traded REIT shares.
• The exchange is not considered a “sale,” so no immediate taxes are due.
• Eventually, selling the REIT shares is a taxable event.

When to Use a 721 Exchange:

• You’re ready to exit direct ownership and prefer passive income from institutional-quality real estate.
• You want exposure to REIT-diversified portfolios with professional management.
• You’re looking to reduce management burden while deferring taxes.

The Role of Delaware Statutory Trusts (DSTs)

A DST is a legal entity that allows multiple investors to hold fractional interests in institutional-grade real estate. DSTs are eligible for 1031 exchanges, making them a popular tool in exit planning.

How DSTs Support 1031 and 721 Strategies:

• You can exchange your property into a DST using a 1031 exchange.
• Some DSTs are structured with a potential “721 exit”, where the DST’s underlying assets may be contributed to a REIT.
• This provides a stepping stone: 1031 ➝ DST ➝ 721 ➝ REIT shares.

Benefits of DSTs in Exit Planning:

• Passive ownership with no landlord responsibilities.
• Access to institutional-grade properties with professional asset management.
• Diversification by property type and geography.
• Preserves 1031 eligibility and future estate step-up in basis.

Choosing the Right Path: 1031 vs. 721

Feature1031 Exchange721 ExchangePrimary GoalTax deferral + continued ownershipTax deferral + transition to REITOngoing ManagementYes, unless you use a DSTNo, REIT handles asset managementEstate Planning ImpactStep-up in basis at deathMay convert to REIT shares pre-deathLiquidityIlliquid (unless DST has exit)Eventual liquidity via REIT sharesTimeline Restrictions45/180-day rulesNo strict timeline once in DSTInvestor ProfileActive investors or DST usersPassive, long-term income seekers

Final Thoughts

Both 1031 and 721 exchanges are valuable tools—but the right fit depends on your financial goals, time horizon, and appetite for active property management. A Delaware Statutory Trust often acts as a bridge between the two, allowing you to maintain tax deferral while transitioning into a fully passive investment structure.

If you’re approaching a real estate exit, it's critical to evaluate your options in advance. A qualified advisor can help you weigh tax implications, liquidity needs, and estate planning goals to build a transition plan that supports your long-term wealth strategy.

Disclosures: This post is for informational purposes only and should not be considered tax or legal advice. Real estate exchanges involve complex rules, and you should consult with a qualified tax advisor, attorney, or financial planner before proceeding with any exchange strategy.