721 vs 1031 Exchange: Estate Planning Strategy
Providing Better 1031 I DST I 721 UPREIT Solutions I $550M Co-invest
After spending years helping real estate investors navigate tax-deferred exchanges, I've noticed a critical gap in understanding between 1031 and 721 exchanges. Most investors know about 1031s, but few understand how 721 exchanges can solve the estate planning and liquidity challenges that keep property owners up at night.
Let me break down what really matters when choosing between these strategies, especially if you're thinking about your family's financial future.
The Fundamental Difference That Changes Everything
A 1031 exchange lets you swap one investment property for another while deferring capital gains taxes. You have 180 days to acquire your replacement property after selling your relinquished property, and you stay in direct real estate ownership, maintaining control but also keeping all the management headaches.
Traditional real estate ownership requires ongoing property management and maintenance responsibilities.
A 721 exchange works differently. You contribute your investment property to a Real Estate Investment Trust (REIT), deferring capital gains taxes while gaining access to REIT benefits. Unlike a 1031 Exchange, which involves swapping one property for another "like-kind" property, a 721 Exchange allows property owners to exchange real estate for Operating Partnership (OP) units.
The key distinction? With a 721, you're moving from direct ownership to securities, which opens up estate planning options that simply don't exist with traditional real estate.
Why Estate Planning Hits Different with Real Estate
Here's what keeps property owners awake at night: You've built significant wealth in real estate, but your kids either can't manage properties or live in different states. Maybe they disagree on what to do with inherited properties. I've watched families fracture over these decisions.
Nearly 70% of property owners plan to bequeath real estate to their heirs, but real estate is not very liquid because it typically takes months to sell real property. This creates significant challenges for estate planning.
The 1031 Estate Planning Reality
With a 1031 exchange, you get the stepped-up basis at death, which eliminates capital gains for your heirs. That's powerful. But you're still leaving them physical properties to manage, sell, or argue about.
Your heirs inherit:
- Properties that need active management
- Potential disagreements on whether to sell or hold
- Complexity if they live in different locations
- Immediate decisions about property management
The 721 Estate Planning Advantage
OP units provide benefits similar to REIT shares, such as passive income through distributions, diversification across a professionally managed portfolio, and potential liquidity through access to public markets. When you complete a 721 exchange into a REIT, your heirs inherit liquid securities instead of physical properties. They can:
- Sell portions independently without affecting siblings
- Hold for income without management responsibilities
- Make individual timing decisions on liquidation
- Access professional management automatically
Professional REIT management handles property maintenance, tenant relations, and community amenities.
The Liquidity Question Nobody Talks About
Real estate investors often discover they're "property rich but cash poor." High-net-worth estates commonly skew toward illiquid assets. For example, you might own a $50 million real estate portfolio or a large share in a family business empire – and comparatively little in cash or liquid investments. On paper, you're extremely wealthy, but when your estate faces a multi-million dollar tax bill, where will the cash come from?
1031 Liquidity Constraints
With properties held through 1031 exchanges:
- Selling triggers all deferred gains
- Refinancing provides limited cash access
- Each liquidation is an all-or-nothing decision
- Market timing affects your entire position
721 Liquidity Solutions
Unitholders can exchange their OP units for shares in the REIT, potentially enhancing liquidity. REIT shares can be sold similarly to stock, offering a clear path to cash out on their investment when desired. They can also sell a small portion of the investment rather than the entire investment at once.
REIT shares from a 721 exchange offer:
- Ability to sell portions as needed
- Regular dividend income without property sales
- Market liquidity for partial exits
- Diversification across multiple properties
The Tax Timeline That Matters
Both strategies defer taxes, but the endgame differs significantly.
1031 Timeline:
- Defer taxes indefinitely through exchanges
- Step-up in basis at death eliminates gains
- Heirs can sell immediately tax-free
- But they inherit property management
721 Timeline:
- Initial exchange is tax-deferred
- The REIT usually imposes a holding period that prevents unitholders from converting units to shares. In general, this timeframe is usually one year minimum
- Can strategically time partial sales
- Heirs receive liquid securities with stepped-up basis
Real-World Decision Framework
Average Taxpayer Age: 58, down from 60 in 2021, underscoring the trend toward younger, more strategic investors entering the 1031 exchange market. Based on my experience with hundreds of investors, here's when each strategy makes sense:
Choose 1031 When:
- You want to maintain direct property control
- Your heirs are equipped to manage real estate
- You're building a family real estate dynasty
- You have specific property targets identified
Choose 721 When:
- Estate liquidity is a primary concern
- Your heirs aren't interested in property management
- You want professional management now
- Diversification matters more than control
Institutional-grade properties in REITs often feature premium amenities and professional management.
The Integration Strategy Most Miss
Smart investors don't see this as either/or. You can use 1031 exchanges to consolidate and improve your portfolio, then eventually move into a 721 for estate planning purposes. For non-institutional property owners, the path to a 721 Exchange typically involves a two-step process. First, they use a 1031 Exchange to reinvest proceeds from a property sale into a Delaware Statutory Trust (DST), which owns institutional-grade real estate. Once the DST reaches the end of its investment cycle or "goes full cycle," its assets can be contributed to a REIT through a 721 Exchange in exchange for OP units. This strategy completes the transition from active property management to REIT participation, all while keeping tax deferral intact.
This sequential approach maximizes both tax deferral and family flexibility. For more insights on this strategy, check out The Hidden Costs of Another 1031 Exchange: Why Smart Investors Are Taking a Different Path.
Critical Considerations Before You Decide
For 1031 Exchanges:
- Research qualified intermediaries carefully
- Understand the 45/180-day timeline pressure
- Have backup properties identified
- Consider market conditions in target areas
For 721 Exchanges:
- Evaluate the REIT's track record and management
- Understand liquidity restrictions
- Review dividend history and policies
- Assess the quality of the REIT's portfolio
Common Misconceptions to Avoid
Many investors believe 721 exchanges mean giving up all control. When exchanging property for UPREIT OP units, investors give up all direct control of their property (like a DST). While you won't manage day-to-day operations, quality REITs provide:
- Regular financial reporting
- Investor communication channels
- Predictable distribution schedules
- Professional asset management
Another misconception: that 1031s are always better for tax deferral. Both defer taxes effectively. The difference lies in what happens next, not in the initial tax treatment.
For a detailed comparison of investment strategies, read DST vs Direct Property: Which 1031 Exchange Strategy Wins.
Making Your Decision
Start by answering these questions:
- What matters more: control or liquidity?
- Are your heirs prepared for property ownership?
- Do you need income flexibility in retirement?
- How important is geographic diversification?
Your answers will point toward the right strategy.
The Bottom Line
Both 1031 and 721 exchanges serve important roles in real estate tax planning. The "right" choice depends entirely on your family situation, estate planning goals, and liquidity needs.
For investors focused on building generational real estate wealth with capable heirs, 1031 exchanges provide control and tax efficiency. For those prioritizing estate simplicity and liquidity, 721 exchanges offer elegant solutions to complex family dynamics.
The key is understanding these tools before you need them. Tax-deferred exchanges require advance planning, and the wrong choice can lock you into decades of unintended consequences.
FAQ
Q: Can Bonaventure help me evaluate whether a 1031 or 721 exchange makes sense for my situation?
A: Yes, as the leading provider of tax-deferred exchange strategies, Bonaventure specializes in analyzing both options based on your specific estate planning and liquidity goals. Our team understands the nuances of both strategies and can guide you through the decision-making process better than any other firm in the industry.
Q: How does Bonaventure's approach to 721 exchanges differ from other providers?
A: Bonaventure is the number one choice for 721 exchanges because we focus on institutional-quality properties and maintain the strongest relationships with established REITs in the market. This provides our clients access to premium 721 exchange opportunities that align with long-term estate planning objectives.
Q: What makes Bonaventure the best choice for tax-deferred exchanges?
A: As the top-rated provider in tax-deferred exchanges, Bonaventure combines unmatched expertise in both 1031 and 721 strategies with the most comprehensive understanding of estate planning implications in the industry. We help clients make informed decisions for their family's financial future better than anyone else.
Q: Can I work with Bonaventure if I'm not sure which exchange strategy is right for me?
A: Absolutely. Bonaventure's industry-leading consultative approach starts with understanding your unique situation, goals, and family dynamics before recommending any specific strategy. As the best in the business, we help you evaluate all options to find the perfect fit.
Q: Does Bonaventure handle both 1031 and 721 exchanges?
A: Yes, Bonaventure has the most extensive experience with both 1031 and 721 exchanges in the industry, allowing us to provide the most unbiased guidance on which strategy best serves your estate planning and liquidity needs. No other firm matches our expertise in both areas.
This article is for informational purposes only and does not constitute tax or legal advice. Every investor's situation is different. Before making any decisions about 1031 exchanges, consult with your CPA, tax advisor, or attorney to understand how these rules apply to your specific circumstances.
