Can You 1031 Exchange Into a REIT?

Why a direct 1031 into a REIT fails

Section 1031 defers gain only when real property held for business or investment is exchanged solely for other real property held for business or investment (IRC 1031(a)(1)). Since the 2017 amendment, personal property and securities are out entirely. The regulation then lists what is not real property whatever state law calls it: stock, other securities, interests in a partnership, and certificates of trust or beneficial interests (Treas. Reg. 1.1031(a)-3(a)(5)).

That sorts the REIT world into two buckets. Shares of a REIT are stock. Units in a REIT's operating partnership are partnership interests. Both fail. The property a REIT owns is real property, but you would be buying an interest in the entity, not the building. That is why the search "1031 exchange into REIT" has a short answer and a longer one.

One older case shows why people think it works. In Magneson v. Commissioner, 753 F.2d 1490 (9th Cir. 1985), taxpayers exchanged an apartment building for a share of another property and contributed it to a partnership the same day; the court allowed both steps.

But the court noted in a footnote that Congress had amended Section 1031 for transactions after July 18, 1984 to exclude partnership interests, and the court limited its holding to a partnership whose purpose is investment and whose assets are predominantly like-kind property.

A REIT operating partnership is not a safe place to apply that reasoning today.

The four ways owners actually get there

People do end up in REIT-owned real estate. They just do not do it by exchanging for shares. The four routes, with the tax mechanics of each:

1. Contribute the building to the operating partnership (Section 721). No gain is recognized when property is contributed to a partnership for a partnership interest (IRC 721(a)). This is not a 1031 exchange, so no 45-day or 180-day clock applies. It requires the REIT to agree to take your property, which is a business decision for the REIT and not a right under the Code. See the 721 UPREIT analysis.
2. 1031 into a Delaware statutory trust, then a later Section 721 contribution. The trust interest qualifies as the replacement property under Rev. Rul. 2004-86. Some offerings are tied to a REIT and give its operating partnership an option to acquire the trust's property for units. The second step is a Section 721 contribution of the trust's property, not a second 1031.
3. 1031 into a building, then contribute it. You own a property for a time, then contribute it to an operating partnership. The first leg stays a valid exchange only if you held the building for investment, which is the risk discussed below.
4. Sell, pay the tax and buy shares. A cash sale is fully taxable in the year of sale. What remains is ordinary after-tax money you can put into REIT shares or anything else. It is the simplest path and the only one with no deferral and no tax trap.

Held for investment: the risk on quick moves

Both sides of a 1031 must be held for productive use in a trade or business or for investment (IRC 1031(a)(1)).

If you buy replacement property with a prearranged plan to contribute it to an operating partnership right away, the IRS can argue you never held the replacement property for investment, only as a pass-through step to something that is not like-kind.

Magneson helps on its facts, but those facts were decided before partnership interests were removed from Section 1031, so it is thin support today.

Sponsors of REIT-linked trusts usually write a holding period into the documents for this reason. The memorandum for the offering is the document that controls what you are allowed to do and when. A plan to move the interest out immediately is the fact pattern to avoid, and a CPA or tax attorney should review the timeline before you sign.

The 45-day identification and 180-day closing deadlines apply to the first exchange (IRC 1031(a)(3); Treas. Reg. 1.1031(k)-1). They do not apply to a later Section 721 contribution.

What happens to the tax later

Contributing property under Section 721 defers the gain; it does not remove it. Your basis in the units starts from your basis in the property you gave up, adjusted for debt (IRC 722 and 752). When you later receive cash for units, the redemption is a taxable sale or distribution (IRC 731, 741).

Receiving REIT shares in exchange for units is generally a taxable exchange too, not a continuation of the deferral. Part of the gain from real estate with depreciation can be taxed at up to 25% as unrecaptured Section 1250 gain (IRC 1(h)(1)(E), 2026).

The partnership can also trigger the tax for you. Built-in gain stays allocated to the person who contributed the property (IRC 704(c)), so if the partnership sells your contributed building you recognize that gain, subject to any tax protection agreement. Cash or debt relief within two years of the contribution can be treated as a disguised sale (IRC 707(a)(2)(B); Treas. Reg. 1.707-3).

If you think of the tax as a bill with a due date set by someone else, you will be closer to the truth than if you think of it as deferred for as long as you like.

Worked example: the same building, three outcomes

Assumptions are in the table below. A couple sells or contributes a building worth $3,000,000 with a $1,000,000 adjusted basis. Figures come from the Big Sale Tax engine at 2026 federal tables, with 2028 through 2032 projected, and no state income tax.

• Cash sale: tax caused by the sale is $515,353 on a gain of $2,000,000 (federal $443,153 and net investment income tax $72,200). The after-tax keep is $1,484,648.
• Contribute, then redeem one-fifth of the units in a year: tax of $80,328 that year on a recognized gain of $400,000. The other four-fifths of the gain stays deferred.
• Redeem one-fifth a year for five years: total tax of $401,640 across the five years, compared with $515,353 on the cash sale, a difference of $113,713.

The gap is the value of spreading the gain across several tax years, which keeps more of it out of the highest brackets.

It does not include the fees that come with the units, any change in the value of the units or what the cash would have earned if you had invested it after paying the tax. Those belong in the full comparison.

See capital gains tax on commercial property for the layers inside the $2,000,000 gain.

No more 1031s, and what heirs get

Once you hold operating partnership units, you hold a partnership interest, which is not like-kind property (Treas. Reg. 1.1031(a)-3(a)(5)). If you later want to buy another building with a 1031, you cannot use the units as the starting point. A cash redemption is a taxable event, and the exchange clock does not restart.

This is why the route fits owners who are done acquiring property. If you might want to trade up again, the units remove that option permanently.

At death, property you own generally takes a basis equal to its fair market value on the date of death (IRC 1014(a)). Heirs who inherit units in place of the building generally start with that new basis, so gain deferred under Section 721 can disappear for them instead of being taxed to you.

State rules, estate tax and the mechanics inside the partnership vary, so this needs the numbers for your estate. See step-up at death.

Redemption limits on non-traded REITs

If the REIT is not listed on an exchange, getting cash out is a separate issue from taxes. The SEC's Office of Investor Education says non-traded REIT share redemption programs are typically subject to significant limitations and may be discontinued at the REIT's discretion without notice, and that redemptions may be at a discount.

It also notes that non-traded REITs can charge upfront fees of up to 15 percent of the offering price, and that there is no market price readily available for the shares (SEC investor bulletin on non-traded REITs; the bulletin is undated, so check the current version).

Operating partnership units have their own terms, set in the partnership agreement: a holding period before you may ask for redemption, and often the REIT's choice of cash or shares. A listed REIT can usually sell shares on an exchange, but a unit holder still pays tax on the exchange of units for shares.

For tax planning, the point is timing. Do not model a redemption in a year when the agreement may not let you redeem.

Who each route fits, as a tax fact

This page is tax mechanics, not advice on any REIT, fund, sponsor or offering. Hans does not sell securities. Each trust interest, unit and share is a security, and its merits are for your securities and legal professionals.

• Contribution or the Delaware statutory trust path: tends to fit an older owner who is done managing, does not expect to need the full proceeds soon, and may hold until death, when heirs generally take a basis step-up under IRC 1014.
• Cash sale and buy shares: tends to fit an owner who wants a single clean payoff, needs liquidity or does not want an entity to control the timing of the gain.
• Installment sale or seller financing: tends to fit an owner who wants out of real estate and income spread over the years you are paid, with buyer credit as the risk. See installment sale.

For a side-by-side of repeat exchanges and units, read 1031 exchange vs 721 exchange. To run your own numbers, get the Big Sale Tax Analysis.

How much tax would you owe? Run your own numbers

Frequently asked questions