How the transaction works.
Every exchange of this kind follows the same legal steps. How it plays out depends on each owner’s situation and property.
If the trust sells its property, you can generally do another 1031 exchange with your share. A §721 contribution ends that option for good.
The timing and terms of the §721 step vary by program. Our client area compares them.
Step one: the exchange. Section 1031 defers the gain when sale proceeds are reinvested into other like-kind real property. Three rules must be followed:
- You never touch the money. A qualified intermediary must hold the proceeds from closing. Taking receipt of the funds, even briefly, disqualifies the exchange.
- 45 days to identify. Replacement property must be formally identified within 45 days of closing on the property you sold.
- 180 days to close. The replacement purchase must complete within 180 days of that same closing.
These deadlines are statutory. They do not extend for financing that falls through, a sponsor that closes its offering, or a slow decision.
To defer the full gain you generally must acquire property of equal or greater value and replace the debt on the property you sold, with new debt or added cash. Many DSTs come with financing already in place, which can make the debt easier to replace.
Step two: the replacement property. A Delaware Statutory Trust holds real property and issues fractional beneficial interests. Revenue Ruling 2004-86 established that those interests can qualify as like-kind replacement property, which is what makes the structure work here. The sponsor handles day-to-day management, but the trust itself generally cannot refinance, raise new capital, or reinvest sale proceeds. That rigidity preserves the tax treatment, and limits the options if a property runs into trouble.
Interests are private placements available only to accredited investors. Most are offered under a Regulation D exemption that bars public advertising, and access is usually through a broker-dealer or a registered investment adviser. There is no secondary market, and you exit only when the trust sells its property or contributes it under §721.
Step three: the 721 conversion. The property held by the DST may later be contributed to a REIT’s operating partnership under Section 721. Your interest becomes operating partnership units and the deferral continues. In most programs, both the conversion and its timing are the sponsor’s decision. Two to three years is a common expectation, not an obligation.
Step four: what you hold at the end. For most owners, this is where it stops. The OP units pay distributions like REIT shares, represent the same underlying portfolio, and require nothing further of you. Converting them into actual REIT shares is optional, generally available about a year after the contribution, and a taxable event that recognizes the deferred gain. So it is usually done only when cash is wanted, and only in the amount wanted. If the units are held for life, beneficiaries may receive a stepped-up basis.