Short answer: A 721 exchange contributes property to a partnership, usually a REIT's operating partnership, in return for partnership units, while a 1031 exchange swaps one investment property for another. Both defer the tax, but a 721 is a one-way door: once you hold units, you cannot do another 1031 exchange.
Reviewed by Jon Hilley. Last updated September 29, 2026.
A Section 721 exchange is one of the 1031 exchange alternatives real estate investors hear about most, usually as an exit into a REIT. Both sections defer tax on your gain, but you end up owning very different things. After a 1031 exchange you own real estate. After a 721 exchange you own an interest in a partnership that owns real estate.
That difference drives everything else: control, liquidity, diversification and whether you can defer again later. Many investors use the two together, first a 1031 into a Delaware statutory trust, then a 721 into a REIT's operating partnership.
Key rules
- 1031 is real property for real property: Gain is deferred when investment or business real estate is exchanged for like-kind real estate (IRC §1031(a)(1))
- 721 is property for a partnership interest: No gain is recognized when you contribute property to a partnership in exchange for an interest in it (IRC §721(a))
- Partnership units end the 1031 chain: Operating partnership units are not real property, so they cannot be exchanged under Section 1031 (Treas. Reg. §1.1031(a)-3)
- Disguised sales are taxable: Cash or other property the partnership pays you in connection with the contribution can be treated as a sale (IRC §707(a)(2)(B))
- Debt shifts can create gain: If your share of liabilities drops when you contribute mortgaged property, the reduction is treated like cash (IRC §752)
- DST interests bridge the two: A properly structured DST interest counts as real estate for a 1031 exchange (Rev. Rul. 2004-86)
What is a 721 exchange in real estate?
In real estate, a 721 exchange usually means contributing property, or DST interests, to the operating partnership of an UPREIT. An UPREIT is a REIT that owns its properties through a partnership. In return you receive operating partnership units, which typically pay distributions similar to REIT dividends and can later be redeemed for cash or converted into REIT shares, usually after a lock-up period the REIT sets.
The contribution itself is tax-free. Redeeming units or converting them to REIT shares is a taxable event, and your deferred gain comes due at that point.
How a 721 and a 1031 exchange compare
Deadlines and intermediaries
The 721 contribution itself has no 45-day or 180-day deadlines and needs no qualified intermediary. If you reach the REIT through a DST, though, the 1031 exchange into the DST still follows all the normal 1031 exchange rules.
What you own
A 1031 exchange leaves you holding specific real estate, directly or through a DST or tenancy-in-common interest. A 721 exchange leaves you holding a slice of a large, diversified portfolio managed by the REIT.
Control and effort
With a 1031 exchange into property you own directly, you control leasing, financing and when to sell. With OP units, you give up control entirely. For investors tired of managing tenants, that trade can be the point.
Future flexibility
After a 1031 exchange you can keep exchanging for as long as you like. After a 721 exchange you cannot go back into a 1031, so the next step is either holding the units or paying tax on some or all of them.
Liquidity and diversification
OP units can often be redeemed in portions, which lets you sell down gradually and spread the tax over several years. A single rental building cannot be sold a piece at a time as easily.
Estate planning
Both paths can end with a step-up in basis at death (IRC §1014), so heirs who inherit the real estate or the units may never pay tax on the deferred gain.
Example: exchanging vs. contributing a $2,000,000 property
Assume a property worth $2,000,000 with an adjusted basis of $800,000 and no debt. To keep the numbers simple, ignore depreciation and other basis changes during the holding period.
- Built-in gain: $1,200,000
- 1031 into a $2,000,000 replacement property: $0 tax now, $1,200,000 deferred, $800,000 basis, can exchange again
- 721 into $2,000,000 of OP units: $0 tax now, $1,200,000 deferred, $800,000 basis in the units
- Value of the OP units three years later: $2,200,000
- Half of the units redeemed: $1,100,000
- Basis allocated to the redeemed units: $400,000
- Taxable gain on the redemption: $700,000
- Units still held: $1,100,000 of value with $400,000 of basis, gain still deferred
In this simplified example, the 721 investor takes $1,100,000 off the table and pays tax on $700,000, while the other half stays deferred. The 1031 investor has no way to cash out part of a single building without selling it, but can keep deferring indefinitely through more exchanges. Part of any taxable gain reflecting prior depreciation would be taxed at up to 25%.
Other questions investors ask
What is the downside to a 721 exchange?
You give up future 1031 exchanges, control of the property and control over when gain is triggered, because redeeming or converting units is taxable. Cash or debt relief at contribution can create gain, and in the DST path the 721 step happens only if the sponsor decides to do it.
What types of properties qualify for a 721 exchange?
Any property the REIT's operating partnership agrees to accept. REITs generally take only property that fits their portfolio, often larger institutional-quality buildings, which is why many smaller investors reach a 721 through a DST that the sponsor later contributes.
How much does it typically cost to do a 1031 exchange?
At 1031 Specialists, a standard delayed exchange is $1,195 and a reverse exchange is $7,995, plus the usual closing costs. If your replacement is a DST, its offering carries its own sponsor fees. See how much a reverse 1031 exchange costs.
Common mistakes
- Treating a 721 as a reversible step. We talk with investors who assume they can exchange OP units back into real estate later. They cannot.
- Contributing mortgaged property without modeling the debt. A reduction in your share of liabilities can create taxable gain at contribution. Have your tax adviser run the numbers first.
- Buying a DST only for a promised REIT exit. The 721 step in a DST is generally at the sponsor's option and may take years or never happen.
