1031 DST vs. 721 Exchange

You can start with a 1031 exchange into one or more DSTs and later move into a 721 exchange when the DST property sells. This is a common succession strategy that preserves flexibility until you're ready to exit the 1031 cycle. However, the reverse isn’t possible: once you complete a 721 exchange, you can’t return to a 1031 exchange. 

If the REIT is acquired or taken private, your OP units will convert into whatever the REIT shareholders receive (cash, shares, or a mix), and the conversion is typically taxable, triggering the recognition of all deferred gains. This is a key risk of 721 exchanges, as corporate actions outside your control can force tax recognition. Review the operating partnership agreement and evaluate the REIT’s stability before proceeding.

The general safe harbor is a two-year holding period. In practice, DST investors are locked in until the sponsor sells the property, typically for 5–10 years, with no secondary market and virtually no way to exit early. If you need liquidity sooner, DST may not be the right fit. Most 721 agreements require a 1–2 year holding period (sometimes longer) before you can redeem or convert OP units. This protects the tax-deferred status and lets the REIT integrate the property. Early redemption is usually denied or penalized.

Emergency liquidity is extremely limited in both DSTs and 721 exchanges. DST interests can’t be sold or transferred early, and you’re locked in until the sponsor sells them—typically within 5–10 years. For 721 exchanges, redemption requires REIT approval, and requests can still be denied even after the holding period. Given the likelihood of early access is low, you shouldn’t invest funds you may need within 5–7 years.

DSTs often include multiple fees (acquisition, asset management, property management, disposition, and financing), which can add up. While 721 exchanges have lower upfront costs, you’ll still incur ongoing REIT fees, including management, operating, and potential performance fees. In both cases, fees can meaningfully affect returns, so a thorough fee review is essential during due diligence.

DST distributions come from rental income and typically target 4–6%, but they’re not guaranteed and vary with property performance. In a 721 exchange, OP unit holders receive the same distributions as REIT shareholders, typically 3–7% and may benefit from greater stability through broader diversification. Both types of distributions are generally taxable as ordinary income. 

Finding qualified DST sponsors or REITs for 721 exchanges requires thorough vetting. Work with a qualified intermediary for referrals and consult advisors who specialize in 1031/721 transactions. Look for sponsors with long, transparent track records and verify SEC registration and Form ADV history. For REITs, review SEC filings, attend presentations, and speak with the investor relations team. Always seek independent verification—don’t rely solely on marketing materials. [What is ADV?] 

A distinct advantage of an exchange into a Qualified Opportunity Fund (QOF) is that capital gain (including section 1231 gain) from the disposition of any property (i.e., not limited to real property) can be deferred if invested in qualified opportunity zone property, which includes real property. Similar to the timing requirements applicable to a 1031/DST exchange, a taxpayer has 180 days to invest the proceeds from a qualifying sale. The significant benefit offered by a QOF exchange is that all economic appreciation is untaxed if the investment is held for 10 years. However, there is a mandatory “liquidity event” on December 31, 2026, such that any deferred gain (reduced by certain basis increases for investments held for 5 or 7 years) must be recognized, possibly resulting in the recognition of phantom income.