The United States is undergoing a historic intergenerational wealth transfer. With over $80 trillion expected to change hands by 2045, real estate investors are seeking thoughtful ways to simplify portfolios, defer taxes, and plan for ownership transitions. Navigating this complex landscape requires both a clear understanding of available options and careful investment selection.
In this article, we’ll first discuss various tax deferral strategies. Then, we’ll explore the advantages and disadvantages of these structures.
1031 exchange: A foundation for tax-deferred real estate investing
A 1031 like-kind exchange is a tax-deferred reinvestment strategy in which you, as a real estate investor, sell real property and reinvest the proceeds into a new, “like-kind” property while deferring capital gains taxes on the sale.
The process works by identifying replacement properties within 45 days of selling the original property and completing the purchase within 180 days. The purchase price of the new property must be equal to or greater than that of the net proceeds, and a qualified intermediary must handle the transaction to maintain IRS compliance. Most importantly for this discussion, successfully executing a 1031 exchange requires your active involvement — including ongoing management and operation of the real estate.
Delaware Statutory Trusts: A passive 1031 exchange alternative
Delaware Statutory Trusts (DSTs) have gained popularity as a modern alternative to traditional 1031 exchanges. A DST is a passive trust that owns one or more real properties. DSTs are designed to reduce the day-to-day operational obligations typically associated with direct real estate investing.
Most importantly, under current IRS rules, DSTs qualify as like-kind property for the purposes of a 1031 exchange. For the most part, the rest of the process of a DST real estate investment mirrors the process of executing a 1031 exchange.
DSTs can exist as standalone real estate investment opportunities, but investment managers are increasingly using DSTs as a means to accomplish a Section 721 exchange.
Section 721 exchange: A way to leverage DST assets in a REIT structure
Section 721 exchanges further build on the benefits of the standalone DST structure, unlocking the potential for greater diversification and flexibility.
Under Section 721 of the Internal Revenue Code, a DST may contribute its assets to a REIT operating partnership without incurring an immediate tax liability. In exchange for their DST interests, each investor receives “operating partnership units,” which have exposure to all assets in the broader REIT. This is sometimes referred to as an “UPREIT” transaction — referring to an “umbrella partnership real estate investment trust” — the name of the specific REIT operating partnership structure that allows for this process. Often, the operating partnership and contributing DST will enter into a tax protection agreement, where the partnership will not sell the contributed property for a specified period and will reimburse the contributor for any taxes triggered if it does.
Increasingly, institutional investment managers are leveraging this structure to permit investors seeking access to a broad, professionally managed real estate portfolio while retaining the tax-deferral benefits of a traditional 1031 exchange.
DST-to-721 structures: Key benefits over traditional 1031 exchanges
The two-step DST-to-721 process provides a handful of unique benefits over the standard 1031 exchange: diversification, passivity, divisibility, and flexible estate planning.
Diversification
A DST-to-721 investment can be a meaningful portfolio diversification tool. Through this process, you can transform a highly concentrated real estate position — often the outcome of a traditional 1031 exchange — into an ownership interest in a broad, professionally managed portfolio.
In a standard 1031 exchange, you typically exchange into a single replacement property, maintaining exposure to the risks and performance of that one asset. These risks could include local economic changes, tenant turnover, or other building-specific problems. Investing in a DST with a 721-exchange option can give you exposure to many properties across multiple markets and sectors. This diversification may help mitigate idiosyncratic single-asset risk and access property types that may otherwise be difficult to invest in directly, such as large multifamily or industrial assets.
Note, however, that while owning properties across multiple markets offers diversification benefits, it may also require filing tax returns in several states — an important consideration when evaluating the overall investment structure.
Passivity
As noted, DSTs can be a great option if you’re seeking a tax-deferral solution that doesn’t require the ongoing, active management of your investment real estate.
While some investors may desire the control inherent in direct real estate investments, this preference may change or evolve over time. Aging investors looking to spend less time collecting rent or managing renovation projects may no longer wish to be burdened by the ownership of direct real estate. However, an outright sale may result in a large, undesirable tax bill. Investing in a DST with a 721-exchange option may provide a way to retain the tax-deferral benefits while getting back the valuable hours spent on the active management of your investment.
Divisibility
Unlike ownership in a traditional real estate investment or standalone DST, an investment in operating partnership units is divisible. That is, you can redeem (or sell) as many or as few of your shares as you’d like, subject to any restrictions put into place by the investment manager. This allows you to convert a portion of your investment to cash rather than the typical “all or nothing” sale experienced with a traditional real estate investment.
Estate Planning
A notable estate planning benefit of a 1031 exchange is the ability to defer capital gains taxes throughout your lifetime and, upon death, pass the property to your heirs with a full step-up in basis. This step-up can significantly reduce or eliminate the deferred tax liability for your heirs if they wish to sell the property.
The DST-to-721 structure preserves this core advantage while also enhancing it. As detailed above, an investment in operating partnership units is divisible. This provides a lot of flexibility for your heirs. This flexibility is especially valuable when you have multiple heirs with differing or even competing personal investment objectives. In this structure, each heir controls their outcome without impacting the others’. One heir may elect to continue to hold the investment and collect passive income, while another may redeem their investment for cash. All this is accomplished while retaining the beneficial step-up in basis and ongoing tax deferral until each heir’s interest is redeemed for cash.
Should you consider a Delaware Statutory Trust or Section 721 UPREIT as an alternative to a 1031 exchange?
Real estate investors navigating today’s wealth transfer landscape have a range of tax-deferral strategies at their disposal. Traditional 1031 exchanges offer powerful benefits but come with operational complexity and strict compliance requirements. DSTs and Section 721 exchanges are more passive, flexible alternatives that can preserve tax advantages while enhancing diversification and estate planning options. Understanding these structures — and how they align with your long-term goals — is essential to making informed investment decisions.
Why professional guidance matters
Real estate investment decisions are rarely one-size-fits-all. Coordinated guidance across disciplines can align real estate investment selections with broader wealth management, estate planning, and tax strategy goals. In particular, DST-to-721 structures involve legal, tax, and investment complexity, which are often oversimplified in an investment manager’s marketing materials. Ongoing monitoring is essential to evaluate performance and adjust your path forward as needed.
At Plante Moran, our cross-functional wealth management team brings together investment, real estate, tax, and estate planning capabilities to help you navigate these decisions with confidence — without embedded product sales or one-size-fits-all solutions. To explore which strategy aligns with your goals, connect with our team for a personalized consultation.
Opinions expressed in this article are current as of the date of this article, and are subject to change at any time.
Plante Moran Realpoint Investment Advisors (PMRIA) and Plante Moran Wealth Management publish this content to convey general information about our services. Investments and strategies mentioned herein may not be appropriate for you. Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain. You should consult our representatives for advice regarding your own situation.
