Two Passive Paths — and How They Often Connect
Investors who want to step out of active landlording without triggering a large capital gains bill frequently compare two tax-deferred structures: a Delaware Statutory Trust (DST) and a 721 exchange into a REIT (UPREIT). Both deliver passive, professionally managed real estate exposure and defer tax at entry. But they are built on different sections of the tax code, and the interest you end up holding is fundamentally different — one keeps you in real property, the other converts you into a partnership interest in a REIT.
The most important nuance is that these two are not always an either/or choice. Many DSTs today are designed with a planned UPREIT exit, so an investor may pass through both — 1031 into the DST first, then convert into REIT operating partnership units later. Understanding how each works on its own is the key to understanding that two-step path.
Side-by-Side Comparison
| Feature | Delaware Statutory Trust (DST) | 721 Exchange / UPREIT |
|---|---|---|
| What you own | Fractional beneficial interest in a trust | Operating partnership (OP) units in a REIT |
| Governing tax authority | Rev. Rul. 2004-86 (§1031) | IRC §721 |
| Underlying asset | Real property held by the trust | Interest in the REIT’s operating partnership |
| Tax deferral at entry | Via a 1031 exchange | Via a §721 contribution |
| Future 1031 eligibility | Yes — still treated as real property | Generally no — units are not like-kind real property |
| Diversification | One or a few properties in the trust | The entire REIT portfolio |
| Control | None — trustee decides | None — REIT management decides |
| Income | Trust distributions | REIT / partnership distributions |
| Liquidity | Illiquid; no secondary market until sponsor exit | Illiquid units; potential liquidity by converting to REIT shares (taxable) |
| Estate treatment | Step-up at death; heirs may 1031 again | Step-up at death; units typically held or converted |
| Typical use | 1031 replacement; hands-off income | Convert appreciated property into a diversified REIT; estate & liquidity planning |
| Investor eligibility | Accredited investors | Accredited investors |
What You Actually Own
This is the cleanest way to separate the two. A DST leaves you holding real estate. Your beneficial interest represents a fractional share of the actual property (or properties) inside the trust, and under Rev. Rul. 2004-86 that interest is treated as like-kind real property. You are a passive owner of real estate through a trust wrapper.
A 721 exchange changes the character of what you hold. You contribute property into a REIT’s operating partnership under §721 and receive operating partnership units in return. You are no longer holding a slice of a specific building — you hold a partnership interest in the REIT’s whole enterprise. That shift from “real property” to “partnership units” is what drives nearly every other difference below.
Future Exchange Flexibility — the Biggest Divergence
The single sharpest contrast is what you can do next. Because a DST interest is still real property, it can serve as replacement property in a future 1031 exchange — when the DST sponsor sells, investors can generally roll their proceeds into another 1031-eligible property or DST and keep deferring. The deferral engine stays alive.
A 721 UPREIT generally closes that door. Once your property becomes operating partnership units, those units are not like-kind real property, so you typically cannot 1031 exchange them afterward. Deferral continues while you hold the units, but the flexible “exchange again and again” path that a DST preserves is usually gone. For some investors that finality is a drawback; for others who want to consolidate into a single diversified REIT and stop managing exchanges, it is exactly the goal.
Diversification and Liquidity
Diversification favors the UPREIT on breadth. A DST holds one or a few properties, so your exposure is limited to those specific assets and their tenants. A 721 UPREIT ties you to the entire REIT portfolio — often dozens or hundreds of properties across markets and sectors — which spreads risk more widely, at the cost of tying your outcome to the REIT’s overall management and performance.
Liquidity also favors the UPREIT, but only eventually. A DST is fully illiquid: there is no secondary market, and investors generally hold until the sponsor exits the trust. UPREIT operating partnership units start illiquid too, but they can often be converted into publicly traded REIT shares over time, creating a path to liquidity a DST simply does not offer. That conversion is generally a taxable event, so accessing the liquidity usually means recognizing gain — it is a benefit with a tax cost attached.
Taxes, Estate Planning, and the Step-Up
Both structures defer capital gains at entry — the DST through §1031, the UPREIT through §721 — and both are popular in estate planning. Held until death, a DST interest and UPREIT operating partnership units generally both receive a step-up in basis, which can reduce or eliminate the deferred gain for heirs. This makes each a potential “defer until the basis resets” strategy.
The difference at exit: a DST can be 1031-exchanged again during life, so gain can keep rolling forward through real estate. UPREIT units are usually held for income or converted to shares, and converting is generally taxable. So the UPREIT tends to suit an investor whose plan is “hold the units for diversified income and pass them to heirs,” while the DST suits one who wants to keep the 1031 chain open as long as possible.
How DSTs and 721 UPREITs Often Work Together
In practice these are frequently two steps of one plan rather than rivals. A common structure looks like this:
- Sell an appreciated, management-heavy property and complete a 1031 exchange into a DST (deferring the gain, going passive).
- Hold the DST interest while the sponsor operates the property.
- Later, the sponsoring REIT acquires the DST’s property, and investors’ interests convert into operating partnership units under §721 (an UPREIT transaction).
The result: 1031 deferral on the way in, then diversification and a potential liquidity path through the REIT on the back end. This sequencing is complex, fact-specific, and irreversible in important ways — once you’re in UPREIT units, the 1031 flexibility is generally gone — so it should be evaluated carefully with tax counsel before committing.
Which Path Fits?
Neither is universally “better.” A DST tends to fit an investor who wants passive real estate, values keeping the 1031 exchange option open, and is comfortable with full illiquidity and no control. A 721 UPREIT tends to fit an investor who wants the broad diversification of a REIT, a potential liquidity path down the road, and a simpler long-term hold — and who accepts giving up future 1031 exchanges and the tax cost of converting units to shares.
Both carry real estate, market, and financing risk, including possible loss of principal, and both are private placements available only to accredited investors. Which path — or which sequence of the two — is appropriate depends on your full financial picture, your time horizon, and your estate plan, and should be evaluated with a qualified advisor, your CPA, and, for the estate pieces, an attorney.
This comparison is educational only and is not investment, tax, or legal advice. DST interests and 721 UPREIT operating partnership units are private placements available only to accredited investors and involve significant risks, including illiquidity and possible loss of principal. Converting operating partnership units to REIT shares is generally a taxable event. IRS rules governing §1031, §721, and step-up in basis are set by the IRS and Congress and can change. Confirm current rules and your specific treatment with your CPA and tax counsel.
Weighing a DST, a 721 UPREIT, or Both?
The DST-to-UPREIT path is powerful but hard to reverse. Talk through your timeline and estate goals with an advisor who works with accredited investors on 1031 and 721 strategies.