From 1031 to 721: How to Exit Real Estate for Good Without Triggering Taxes

So far in this series we’ve covered the 721 contribution in depth and walked through the foundations and common mistakes of the 1031 exchange. This week we bring the two together. They aren’t competing tools. They’re sequential steps in a multi-decade strategy that sophisticated real estate investors use to defer taxes through their entire investing lives and transfer wealth without recognition. Here’s how the sequence works, when it’s the right move, a fourth option we’re increasingly asked about called the Lazy 1031, how a tenancy in common compares to a DST as a bridge structure, and where the series goes from here.

By Jeremiah Boucher, Founder & CEO, Patriot Holdings

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Consider a real estate investor who has done four 1031 exchanges over eighteen years. Started with a small duplex. Rolled into a larger multifamily. Rolled again into a self-storage facility. Rolled again into two industrial properties. The combined position is now worth roughly $22 million.

The basis on those properties is nowhere near $22 million. After four rounds of deferral and accumulated depreciation, the tax basis sits around $3 million. The embedded gain is closing in on $19 million. If the investor sells today, the tax bill is somewhere between $5 and $7 million depending on the recapture math.

At this point, the investor is tired. They don’t want another property. They don’t want another 1031 cycle. They want to be done. But they also don’t want to write a $6 million check to the IRS for the privilege of being done.

This is the situation the 1031-to-721 sequence was built for. It’s the exit strategy at the end of the 1031 treadmill, and it pulls together the pieces we’ve been building through this series.

The 1031 treadmill problem

The 1031 is a powerful deferral tool. Used once, it pushes the tax bill down the road. Used three or four times over decades and the deferred gain builds up enormously. Every cycle, the basis stays low and the equity grows. The longer the strategy runs, the bigger the trapped gain becomes.

Most long-time real estate investors hit this problem in their late fifties or sixties. They’ve built real wealth, the assets are running well, and they’re starting to think about what life looks like without the day-to-day of operating. But the math punishes them for stopping.

Selling outright triggers the entire accumulated gain. Doing another 1031 puts them right back into operating real estate. Neither answer is what they actually want.

The 1031 treadmill has two exits. The first is what we covered in the 721 estate planning post. The investor holds through death, heirs receive a stepped-up basis under current law, and the entire deferred liability is erased. The second is the 721 contribution, which lets them exit operations during their lifetime while preserving the deferral.

Some investors who hit this point use a combination of both. They contribute their operating properties into a 721 structure during their lifetime, take passive distributions, and hold the LP units through death, depending on the vehicle and associated hold, so the basis steps up for their heirs. The 1031 deferrals they ran for decades get carried all the way to the finish line without ever triggering tax.

How the sequence actually works

An investor in the $22 million position above has three structural paths to consider.

Path one is direct 721 contribution. The investor contributes existing properties directly into a 721-eligible structure, either a public REIT’s operating partnership or a private fund. The receiving entity has to actually want the specific assets and has to be willing to structure the contribution with appropriate tax protection language. When the fit is right, this is the cleanest path.

Path two is 1031 first, then 721. The investor runs one more 1031 exchange, but this time into a property that’s structured from day one to eventually flow into a 721 contribution. This is what some investors do when their current assets don’t fit any 721-eligible vehicle’s portfolio strategy. They 1031 into a Delaware Statutory Trust, or DST, that’s structured to UPREIT into a public REIT after a defined holding period. The DST holds the asset, runs the operations, and when the time is right, the DST contributes the property into the REIT’s operating partnership, and the investor’s beneficial interest in the DST converts to OP units.

Path three is the long-form transition. The investor runs one more 1031 into a more passive replacement, holds it for several years, and then does a 721 contribution when the timing fits both personal circumstances and the receiving fund’s acquisition window. This gives more flexibility on timing but requires the discipline to actually execute the 721 when the moment comes, rather than just running another 1031 because it feels easier.

All three paths achieve the same end state. The investor is out of operations. The deferred tax liability is intact and rolled into the basis of the new units. The position generates passive income. And, under current law, the basis steps up at death and the liability is erased.

The DST as the bridge structure

The Delaware Statutory Trust deserves its own paragraph because it’s the bridge most investors use to make this sequence work, and many investors have never heard of it, or have heard of it, but don’t really understand it.

A DST is a passive investment vehicle that holds real estate. The IRS treats beneficial interests in a properly structured DST as direct ownership of real property, which means an investor can 1031 exchange into a DST and out of a DST. The investor doesn’t operate the property. A trustee or sponsor handles all of that. The investor just holds a beneficial interest and receives distributions.

DSTs come in two flavors for this purpose. The first is a standalone DST that holds a single property or portfolio, generates passive income, and eventually winds up either by selling the underlying assets, which can trigger another 1031, or by holding until the investor’s death. The second is a DST that’s structured from the outset to UPREIT into a specific REIT’s operating partnership after a defined holding period, often two to seven years. This is the structure that creates the 1031-into-DST-into-721 sequence.

DSTs are not for everyone. They have illiquidity and they have sponsor risk. The investor is trusting that the DST sponsor will operate the underlying assets well and execute the UPREIT if that’s the planned exit. But for an investor who wants to bridge from active operating real estate into a fully passive end state with the tax deferral preserved, the DST is often the cleanest legal structure.

Another option we haven’t discussed: the Lazy 1031

Not every investor wants to run another exchange at all. For those who don’t, there’s a different route worth putting on the table, and it’s one we’re increasingly asked about.

The three paths above, and the DST that supports them, all keep you inside the exchange framework. You defer the gain by rolling it forward and never touching it. The Lazy 1031 works from the opposite direction. It isn’t an exchange at all. Instead of deferring the gain by rolling one property into another under Section 1031, the investor sells the property, recognizes the gain, and offsets that gain with paper losses generated by a new real estate investment placed in service in the same tax year. The tool that generates those losses is cost segregation paired with bonus depreciation.

Here’s the mechanism. When an investor puts capital into a new property, or into a syndication or fund that runs a cost segregation study, the study reclassifies components of the building(s) brought in service in a given tax year into shorter depreciation schedules. Under current law, those reclassified components are eligible for 100% first-year bonus depreciation, which the One Big Beautiful Bill Act restored and made permanent for property placed in service after January 19, 2025. That accelerated depreciation shows up as a passive loss on the investor’s return. Passive losses generally offset passive income, and the gain on the sale of a rental property is generally passive. So the depreciation from the new investment can potentially offset some or all of the gain from the property that was sold, depending on the unique tax situation of the underlying investor/operator.

The appeal is flexibility. A traditional 1031 puts the investor on a clock: 45 days to identify a replacement property and 180 days to close. The Lazy 1031 has no such deadlines. The investor generally has until the end of the tax year to get the new asset placed in service, which leaves more room to plan the next move rather than forcing a rushed replacement purchase just to beat a deadline.

The tradeoffs matter, and this is where it differs sharply from a traditional 1031, a DST, or the 1031-to-721 sequence. The Lazy 1031 is a timing strategy, not tax elimination. Taking accelerated depreciation now lowers the basis of the new property, which means more depreciation recapture waiting when that property is eventually sold. As with any tax deferral strategy, it moves the tax bill rather than erasing it. The passive loss rules also have limits. Passive losses generally offset passive income, not ordinary or W-2 income, unless the investor qualifies as a real estate professional or another exception applies. And the size of any offset depends on the investment, the leverage, and the specific assets placed in service. Not to mention, how the underlying state where the property is sold treats bonus depreciation, specifically. This is a strategy to model with a CPA before selling anything, not a rule of thumb.

Where it fits is an investor who is comfortable recognizing the gain, wants to redeploy into new real estate anyway, and would rather offset the tax with a fresh depreciable investment than lock into the identification and closing deadlines of a formal exchange. Where it doesn’t fit is the investor whose real goal is to exit real estate entirely and never recognize the gain. For that investor, the 1031-to-721 sequence and the step-up at death remain the cleaner endpoint. The Lazy 1031 is one more option we’re glad to shed light on, and a conversation we’re happy to have with you and your CPA when/if the timing is right.

“The Lazy 1031 isn’t a replacement for the exchange. It’s another door. For the right investor, it’s one worth walking through, and one we’re always open to discussing.”‍

Jeremiah Boucher, Founder & CEO, Patriot Holdings

Another co-ownership option: the tenancy in common (TIC)

The DST isn’t the only way to hold a fractional, largely passive interest in replacement real estate. The other structure investors ask about is the tenancy in common, or TIC. Like a DST, a TIC lets an investor 1031 into a fractional interest in a larger property alongside other investors. Unlike a DST, a TIC makes each investor a direct co-owner of the real estate rather than the holder of a beneficial interest in a trust.

Here’s how it works. In a TIC, each co-owner holds an undivided fractional interest in the property and appears on the title. The IRS addressed when these arrangements qualify as real property eligible for a 1031, rather than as a partnership interest that would not qualify, in Revenue Procedure 2002-22. That safe harbor lays out the conditions: generally no more than 35 co-owners, with a married couple counted as one, and unanimous consent among the owners on major decisions such as selling the property, refinancing, or signing a major lease. Each co-owner can 1031 into the TIC and later 1031 out of their own interest independently.

The difference from a DST comes down to control and financing. A TIC gives the investor an actual vote. Because you are a direct owner, you have a say in the major decisions, and unlike a DST, a TIC can pursue a cash-out refinance. The flip side is that unanimous consent creates coordination risk. A single co-owner can hold up a sale or a refinance. And because each co-owner is on the title, each is typically named on the mortgage and has to qualify for the financing individually, which is one reason some lenders are cautious about TIC deals. A DST, by contrast, centralizes all of that under a single trustee and a single borrower. Simpler, but with the investor’s control traded away.

What a TIC owner actually reports at tax time

Direct ownership carries straight through to the tax return, and this is the part investors tend to think about only after the first April following the closing. Because each co-owner holds a direct interest in the real estate, each co-owner reports their own proportionate share of the property’s profits and losses. The sponsor or property manager issues an informal statement each year showing that co-owner’s share of rental income, operating expenses, mortgage interest, and depreciation, and the investor carries those figures onto Schedule E of their personal return. Functionally, you file much as though you own a slice of the building directly, provided the arrangement is structured and operated as a true co-ownership for tax purposes, which is a legal and structural question your advisors should confirm.

Debt is allocated the same way. If the property carries a mortgage, each co-owner is generally allocated a portion of that debt in proportion to their interest. That allocation is not a formality. It affects basis, and how much of a loss an investor can use in a given year, depending on their overall tax situation. It also raises the question of who stands behind the loan. In some TIC deals, co-owners are asked to personally guarantee their share of the debt. That is a meaningful difference from a DST, where the trust is the single borrower and the investor is not a party to the loan.

It is also the reason you see so many TIC structures financed with non-recourse debt. Non-recourse limits the lender’s remedy to the property itself, which keeps personal guarantees off the table and generally limits a passive co-owner's exposure to the asset itself, though many non-recourse loans include standard carve-outs worth reviewing with counsel. If you are evaluating a TIC, put the recourse question near the top of your list, right alongside the sponsor’s track record and the terms of the co-ownership agreement. 

Experienced TIC investors typically ask three questions: recourse vs. non-recourse, whether any guarantee is required, and how debt is allocated, and they're worth raising with your CPA and counsel before committing.

For the sequence in this post, a TIC can serve the same bridge role as a DST. An investor can 1031 into a TIC interest and later contribute that interest into a REIT’s operating partnership under Section 721, or the interest can be structured to roll into an UPREIT down the road. Where the TIC fits is the investor who wants fractional, mostly passive ownership but still values a voice in the big decisions and the flexibility to refinance. Where the DST fits better is the investor who wants true hands-off simplicity and a faster, cleaner close. As with everything in this series, which one is right depends on the investor, and it’s a conversation worth having with your CPA and advisor before committing.

What this sequence does for an estate plan

The reason sophisticated tax advisors and estate planners get excited about this 1031-721 sequence isn’t just the deferral during life. It’s what happens at death.

Under current US tax law, the assets in an estate receive a step-up in basis to fair market value at the date of death. Take the investor with the $22 million position carrying $19 million in deferred gain through decades of 1031 exchanges and a final 721 contribution. Heirs inherit those LP units at their current fair market value. The entire $19 million in deferred capital gains and depreciation recapture liability disappears.

The heirs can then redeem the units, sell the converted REIT shares, or hold them. They have flexibility. The decades of tax deferral that the investor built up are transferred to the next generation without recognition.

Two important caveats. First, this is current law, and the step-up in basis has been the subject of repeated legislative proposals to modify or eliminate it for higher-value estates. The strategy works under current law, and a well-structured plan accounts for the possibility of future legislative change. Second, the estate tax itself is separate from the income tax issue. Estates above the federal exemption threshold may still owe estate tax on the value of the inherited assets. The step-up addresses income tax basis, not estate tax exposure. A real estate CPA models the income tax piece. An estate planning attorney addresses the estate tax piece. Both conversations matter.

When this sequence is right, and when it isn’t

This is a multi-decade strategy. It rewards investors who think in fifteen, twenty, thirty year horizons. It’s the wrong strategy for anyone whose timeline is shorter, whose liquidity needs are uncertain, or whose heirs don’t want to inherit illiquid real estate fund units.

It’s the right strategy when the investor is a long-term real estate investor who has built up significant deferred gain, is ready to step out of operations either now or within a few years, has an estate plan and the team to support it, and has other liquid assets outside this structure to handle any near-term cash needs.

It’s the wrong strategy if the investor needs access to their full equity in the next few years, anticipates major lifestyle changes that would require liquidating the position early, or doesn’t have a clear plan for what happens with the structure after they’re gone.

Where the series goes from here

We started this series with a friend of mine who owned two mobile home communities and didn’t want to sell because of the tax bill. Since then we’ve covered the 721 contribution, the mechanics of what you own after, the estate planning play, the foundations of the 1031, the five mistakes that blow up exchanges, and now the sequence that connects them. We’re not wrapping up here. There’s more to come.

The thread running through all of it is the same. The US tax code rewards long-term real estate investment. The rewards aren’t loopholes, they aren’t accidents, and they aren’t reserved for institutions. They’re written into the code specifically to incentivize the kind of patient capital that builds and operates real assets for the long haul. The investors who understand the structure benefit from it. The investors who don’t, pay the bill.

The 1031 exchange and the 721 contribution are the two pillars. Used in isolation, each is powerful. Used together, sequenced over decades, with the right team and the right planning, they create one of the most efficient real estate wealth transfer strategies available under current law. And as we covered above, they aren’t the only routes worth knowing.

In upcoming posts we’ll go deeper on several of these, including a closer look at the Lazy 1031 and the cost segregation math behind it, and how these structures play out inside real portfolios. It takes work to set up. It takes a CPA, an estate planning attorney, and ideally an operator who has run these structures before. But for the investors who do the work, the math is hard to argue with.

“The 1031 and the 721 aren’t competing tools. They’re possible sequential steps. The investors who understand the sequence run their entire real estate career on deferred capital, then hand it to the next generation without recognition.”

‍ Jeremiah Boucher, Founder & CEO, Patriot Holdings

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We can’t tell you if a 1031 or 721 is the best next move, or whether a Lazy 1031 or a TIC interest is worth exploring, as that’s a job for your tax, wealth, and estate planning team, but we are happy to explore how we might support your legacy.

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This content is for informational and educational purposes only and does not constitute tax, legal, estate planning, or investment advice. The 1031 exchange, 721 contribution, Delaware Statutory Trust, and tenancy in common structures each have specific eligibility requirements and limitations. Tenancy in common co-owners hold a direct interest in the underlying real estate and are generally allocated a proportionate share of the property’s income, expenses, and debt, which they report on their individual returns. Depending on the structure and the lender, a co-owner may be required to qualify for financing individually or to guarantee a portion of the debt. Cost segregation, bonus depreciation, and the strategy sometimes called the Lazy 1031 also carry specific eligibility requirements and passive loss limitations, and the offset available depends on individual circumstances. The 100% first-year bonus depreciation described here is current US tax law under the One Big Beautiful Bill Act and may be modified by future legislation. The step-up in basis at death is current US tax law and may be modified by future legislation. Tax and estate outcomes depend on individual circumstances. Consult a qualified CPA, estate planning attorney, and financial advisor before structuring any transaction. Patriot Holdings does not guarantee any specific tax or investment result.