A Whitwell & Co. Client Guide
The 721 Transaction
Deferring tax, simplifying ownership, and preserving legacy for owners of appreciated real estate.
A 721 transaction lets the owner of appreciated real estate contribute their property to a REIT operating partnership in exchange for Operating Partnership Units ("OP Units"), deferring federal capital gains, depreciation recapture, the 3.8% net investment income tax, and applicable state tax. Most individual owners reach this through a two-step sequence: a 1031 exchange into a Delaware Statutory Trust, then a 721 contribution of that interest to a REIT after a holding period. The result: out of active management, into a diversified institutional portfolio, with passive income, gradual liquidity through redemption, and OP Units that may receive a step-up in basis at death.
Why This Matters
Many of the families we serve built real wealth through real estate they have held for years or decades. That success creates a quiet problem: the more a property appreciates, and the more depreciation you claim along the way, the larger the tax bill waiting at the moment of sale. We call this the success tax.
A 721 transaction is one of the most powerful tools available to owners of low-basis property. Used in the right circumstances, it can help you step out of active management, move into a diversified institutional portfolio, defer a significant tax liability, and position your estate for an efficient transfer to the next generation.
The Challenge of Low-Basis Real Estate
Two forces combine to create a large taxable gain. First, appreciation: the property is simply worth far more than you paid. Second, depreciation: the deductions that sheltered your income over the years steadily lowered your cost basis. When you sell, the gap between the sale price and your reduced basis is taxable, and the depreciation you claimed is recaptured at its own rate.
A sale can trigger four separate taxes
- Federal long-term capital gains tax on the appreciation.
- Depreciation recapture tax on the deductions previously claimed.
- Net investment income tax of 3.8% for many high-income owners.
- State income tax, depending on your state of residence.
For a long-time owner, these can combine to consume a meaningful share of the sale proceeds. The result is less capital left to reinvest, and a smaller base on which future growth can compound.
What Is a 721 Transaction?
A 721 transaction takes its name from Section 721 of the Internal Revenue Code, which provides that no gain or loss is recognized when an owner contributes property to a partnership in exchange for an interest in that partnership. In real estate, this is most often done through what is known as an UPREIT structure.
In a typical UPREIT, you contribute your property to the operating partnership beneath a real estate investment trust (a REIT). In exchange, you receive Operating Partnership Units, commonly called "OP Units". Because the contribution is governed by Section 721, the exchange of your property for OP Units is generally not a taxable event. Your built-in gain is deferred, not erased, and carries forward in your new interest.
The common path for individual owners
Because a partnership or REIT interest does not qualify as like-kind property, most individual owners reach an UPREIT in two steps. They first complete a 1031 exchange into a Delaware Statutory Trust (a DST), then, after the DST has been held for a period of time, the REIT acquires the DST property and the investor receives OP Units under Section 721. This two-step path is a deliberate sequence, and the timing rules matter.
How It Typically Works
Contribute or exchange
You contribute appreciated property to the REIT operating partnership, often after first exchanging into a DST under Section 1031.
Receive OP Units
In place of a single building, you now hold units in a professionally managed, diversified operating partnership.
Hold and collect income
OP Units generally pay distributions similar to the REIT's shares, giving you passive income without management responsibility.
Convert at your discretion
After a holding period, OP Units can typically be converted to REIT shares, often on a one-to-one basis, at a time you choose.
Access liquidity as needed
Once converted, shares may be sold or redeemed through the vehicle's share redemption program, allowing you to take liquidity gradually rather than all at once.
Potential Benefits
Tax Deferral
Defer capital gains and depreciation recapture at the time of contribution, keeping more capital invested and working for you.
Passive Ownership
Trade tenants, repairs, and operating decisions for professional management.
Diversification
Exchange a single property and its single-asset risk for a portfolio spread across many assets and geographies.
Income
Pursue tax-advantaged passive income based on the portfolio's performance.
Gradual Liquidity
Access proceeds over time through a share redemption program, on your schedule rather than a buyer's.
Legacy Planning
Hold OP Units during your lifetime and pass them to heirs, who may receive a step-up in cost basis at death, an outcome difficult to achieve with a property you intend to keep selling and exchanging.
Trade-offs and Risks to Weigh
A 721 transaction is powerful, but it is not the right answer for every owner. We help clients weigh the following carefully, based on individual circumstances:
Conversion is a taxable event
When you convert OP Units to REIT shares and sell for liquidity, the deferred gain generally becomes taxable. The strategy defers tax; it does not eliminate it.
A one-way door from 1031
Once you hold OP Units, you generally cannot complete a future 1031 exchange back into direct real estate.
Liquidity is limited
Redemption programs have limits and can be suspended; these are not publicly traded shares you can sell at any moment.
Market and real estate risk
Value and income depend on the portfolio's performance and on conditions such as interest rates, occupancy, financing, and the broader economy. You could lose capital.
Timing rules
The DST-to-UPREIT path follows specific sequencing requirements, and an UPREIT generally should not be promised or guaranteed at the outset.
How This Fits a Whitwell Plan
We think about a family's financial life the way an architect thinks about a structure. A 721 transaction is one possible component, valuable only when it serves the larger blueprint. Our role is to coordinate the moving parts: your tax picture, your income needs, your estate plan, and your goals for impact, so a decision about one property is never made in a silo.
Where a 721 strategy is appropriate, we help you pursue Designed Optionality: the freedom to step back from active management, the clarity of a coordinated plan, and a structure built to serve your family across generations. We provide access to non-traditional investments only when they are thoughtfully vetted and suitable for your situation.
Related deep dives
- Four Paths for Appreciated Real Estate → Side-by-side comparison on a $5M worked example.
- 1031 + DST White Paper (2026) → Mechanics, who fits, ten common mistakes.
A Quiet Invitation
If you are considering a 721 exchange to move from a single property into a diversified, professionally managed portfolio, we should talk before you commit. We do not believe in pressure or hard pitches. We believe in the right relationship with the right people at the right time.
Schedule a 721 Strategy CallThis material is provided by Whitwell & Co., LLC for educational purposes only. It is not tax, legal, or investment advice, and it is not an offer to sell or a solicitation to buy any security. It contains a brief and general description of Sections 721 and 1031 of the Internal Revenue Code. Investments in real estate are illiquid and subject to significant risks, including the possible loss of all invested capital. Risks include changing economic conditions, interest-rate fluctuations, supply and demand, tenant credit and vacancy, rising operating costs, changes in laws and regulations, availability and cost of financing, and acts of nature. All investors should consult their own tax and legal advisors regarding their specific circumstances before pursuing a Section 721 or Section 1031 strategy. Whitwell & Co., LLC is an SEC-registered investment adviser. Access to non-traditional investments is offered only when appropriate and based on individual circumstances. No outcome or return is guaranteed.