Leveraging the 721 Exchange (UPREIT) as a Business Development Tool

by Greg Barrett

I’m sure you are familiar with the tax benefits provided to investors under section 1031 of the tax code.  You may not know, however, that there are other tax loopholes that can be very advantageous to real estate investors. Not only is the 721 Exchange advantageous to investors, but it also creates a tax advantaged strategy for real estate operators to grow AUM.

In this post I will summarize the 721 Exchange and how it can be a useful tool for both investors and operators of commercial real estate. In short, a 721 contribution is a tax deferred transaction similar to a 1031 exchange; however, in this case, the seller contributes the asset in exchange for unites in the partnership (units in the UPREIT). Quick disclaimer; I’m not an attorney or accountant and this is intended to be advice of any sort.

Let’s define the key terms you need to know about 721 Exchanges.

UPREIT: An UPREIT is an Umbrella Partnership Real Estate Investment Trust. This is a corporate structure that allows real estate owners/investors to exchange their property holdings for units in the REIT. It’s an operating partnership subsidiary of a REIT.

Typically, in an UPREIT structure, the REIT holds its assets and conducts its operations through a single operation partnership subsidiary–the Operating Partnership.  The REIT or a wholly owned subsidiary of the REIT serves as the sole general partner of the Operating Partnership, and therefore, the REIT has full control over the operating partnership. When a REIT is owned as a partnership it allows for 721 contributions.

721 Exchange: In a 721 Exchange, the seller of the property contributes their interest in real estate to the operating partnership in exchange for units instead of cash.  As you know, under a normal sale transaction, the seller gets cash at closing. In a 721 contribution, the seller will receive shares of OP units (operating partnership) in the UPREIT vehicle.  The seller receives many of the tax benefits (and others) associated with the 1031 exchange.

Operating Partnership ‘OP’ Units: These are limited partner shares in a in a company that are convertible to REIT (common) shares. OP units have similar economic characteristics to REIT shares in that they can be recipients of dividends. These units can only be converted into shares of the REIT; they cannot be exchanged into an equity interest in an individual property.

The contribution of the property in exchange for OP units is not a taxable event. The seller of the property (recipient of the OP units) can defer taxes until he wishes to convert those units into REIT shares. The exchange is considered a tax free event under section 721 of the Internal Revenue Code. Therefore, as long a the seller holds the OP Units the gains from the transaction will continue to be deferred.

There are a number of benefits to sellers and buyers. I’ll highlight the primary benefits below.

Benefits to Seller

  • Tax Deferral: By contributing the asset in exchange for OP units, you defer taxes because you do not have to pay capital gains at the time of transfer.  By deferring taxes, sellers are able to invest 100% of the gains on sale to purchase shares in the REIT.
  • Tax Planning Flexibility: Heirs will receive the asset with a step up in basis; therefore, they won’t have a taxable gain on the exchange for shares. Note that heirs will receive the OP units at current market value at the time of death.
  • Estate Planning and Flexibility: Physical real estate can be difficult to sell and can lead to conflicts in the division of assets. The UPREIT resolves these challenges by allowing shares to be split up. The shares are much more liquid than the real property. The investor contributing the property determines when they wish to exchange OP shares for REIT shares. Therefore, this structure allows for much more flexibility. Note that when OP units are converted into REIT shares, capital gains tax will be incurred.
  • Regular Distributions: Because their investment will be exchanged into a REIT, they can generally expect to receive quarterly or monthly distributions.
  • Diversification:  REITs have many assets that are different in terms of product type, geography, tenants, etc.; therefore, the investment becomes much more diverse than owning just one asset.
  • Reduced Responsibilities: The seller no longer has to manage the property as it is managed by the REIT. The seller can now benefit from the passive income associated with being a REIT shareholder.

Additional Tax Considerations

One caveat associated with the 721 exchange is that the seller will defer taxes until they are converted to REIT shares or when the REIT sells the property. 

The benefits to sellers is quite significant. Again, the use of the UPREIT structure is typically tax driven.  Its primary objective is to allow owners of real estate assets to transfer their assets into a vehicle without triggering a tax.  The increased liquidity is also a primary driver.

Benefits to Buyer (UPREIT)

721 Exchanges can be a powerful tool for managers of a REIT as well. The primary benefit is its use as a business development tool. More specifically:

  • Property contributions equate bringing capital into the fund. The buyers purchase the assets and are effectively bringing equity into the fund and growing NAV.
  • The tax benefits create incentives for sellers to sell, rather than hold on to the property.  In other words, it creates acquisition opportunities that otherwise wouldn’t be available.

Owners & Developers

Owners and Developers can use the UPREIT to sell in a strong market and obtain attractive pricing. If they don’t have a project to match the proceeds with (deploy the funds into to avoid the taxes), they can use the UPREIT to defer the taxes and avoid paying them during the time in between selling an asset and redeploying the proceeds into new development or investment opportunities.


Brokers can use the UPREIT to help facilitate transactions. Oftentimes, brokers have a hard time convincing investors to sell because the investors don’t know where they will reinvest the capital.  The don’t know they will be able to identify a replacement within 45 days under 1031 guidelines.  An UPREIT solves the issue because the capital will be reinvested into a REIT. In addition to the benefits mentioned above, there is certainty of execution and no risk associated with finding a replacement asset.


UPREITs are most attractive to owners of real estate who are looking to dispose of their real estate and defer capital gains. Unlike a 1031 exchange, in a 721 exchange sellers receive shares of a REIT which comes with many benefits including: tax deferral, increased liquidity, tax planning flexibility, diversification, estate planning flexibility, and regular distributions.

This article isn’t meant to provide all the details one needs to know in order to effectuate a 721 Exchange. It’s very complicated and one needs to be advised by competent advisors who specialize in these types of transactions.

The purpose of this article is to make you aware of a less well known, yet very powerful, way to defer capital gains tax. This structure provides an opportunity for owners of real estate to get out of direct ownership by converting their interest into shares of a REIT. It also allows the mangers of a REIT the ability to grow their AUM through these contributions.

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