REIT shares are securities, so they do not count as real property for a 1031 exchange. The workaround is a two-step path: 1031 exchange into a DST, then a 721 exchange of those interests into REIT operating partnership units, which keeps the gain deferred.
Why you can't exchange into REIT shares
Sell an investment property at a profit, and the capital gains tax can be deferred by rolling the proceeds into another property. That is a 1031 exchange. The obvious next question is whether you can roll into a REIT instead, a real estate investment trust that lets you own a slice of a diversified, professionally managed portfolio. Almost always, no.
REIT shares are securities. A 1031 exchange requires real property for real property, and securities and real property are not like-kind. That holds for publicly traded REITs, non-traded REITs, and private REITs alike. How the shares trade, or whether they trade at all, does not change what they are.
The reason sits in the definitions. Section 1031 permits tax-deferred exchanges of real property for like-kind real property, and the IRS treats real property as land, buildings, improvements, and similar interests tied to tangible assets. A REIT share is an ownership stake in a company that owns real estate, not an ownership stake in the real estate itself.
The line exists to stop investors from using a 1031 exchange to turn real estate into financial securities tax-free. If REIT shares qualified, you could sell a building, move into a liquid, diversified security, and owe nothing, which would erase the boundary between real property and securities for tax purposes. So the rule stays bright-line, meaning no exceptions: real property for real property, securities for securities, no crossover.
The DST-to-721 workaround
There is a legitimate way to reach REIT exposure with tax deferred, but it runs in stages and takes years.
First, you do a standard 1031 exchange out of your property and into a Delaware Statutory Trust, or DST, a structure that holds real property and gives investors fractional beneficial interests in it. Because you are trading real property for a real-property interest, this qualifies as a 1031 exchange. For the rest of the path to work, the DST has to be set up from the start with a 721 pathway, named for the tax section that makes the later step possible.
Then you hold. For roughly 5-7 years you own the beneficial interests as a passive investor and collect distributions.
When the DST reaches its transition point, you contribute those interests to a REIT's operating partnership under Section 721, which lets you hand property to a partnership in exchange for partnership interests without recognizing gain. In return you receive operating partnership units, or OP units, in the REIT, and the gain stays deferred through both steps. The result is REIT-level diversification and institutional management, with tax deferred the whole way.
One thing is worth understanding before you start: once you hold OP units, the 1031 chain is over. OP units are securities, so you cannot 1031 exchange again. It is a one-way door.
This is not a shortcut. It ties up your capital for years, the 5-7 in the DST plus additional time in OP units. But it is the established, repeatable route from directly owned property to REIT exposure without triggering tax.
For how this works in detail, including OP unit liquidity, lock-up periods, and who it fits, see the DST-to-721 path.
Contributing property directly under Section 721 (rare)
Section 721 does not strictly require a DST in between. In principle you could contribute your property straight to a REIT's operating partnership and receive OP units for it, with no gain recognized.
In practice this rarely happens. Most REITs run to specific investment criteria and will not accept ad hoc property from individual investors. Your property would have to fit the REIT's underwriting standards, portfolio strategy, and geographic focus. And a direct contribution takes complex negotiation and legal structuring that most REITs are not set up to handle for a one-off deal.
The DST-to-721 path is the packaged, repeatable version of the same idea. A direct 721 contribution stays possible on paper but is not a practical route for most investors.
Buying REIT shares now, and paying the tax
If you want REIT shares today and are willing to pay the tax, the mechanics are simple: sell the property, pay capital gains tax on the gain, and invest what is left in REIT shares.
Simple, but not cheap. You pay full tax on the gain, which shrinks the capital left to invest by 20-40%, depending on your federal and state rates.
That is the tradeoff in plain terms. Immediate REIT access and full liquidity on one side; a tax bill that permanently reduces the amount you have working for you on the other. Which one fits depends on the size of your gain, your timeline, and how much you value liquidity now against keeping more capital invested.
You cannot roll a 1031 exchange straight into REIT shares. The DST-to-721 path is the established route to eventual REIT exposure with tax deferred, at the cost of several years and reduced liquidity.
Frequently asked questions
Why can't I 1031 exchange into REIT shares?
REIT shares are securities, not real property. A 1031 exchange requires like-kind property, meaning real property for real property, so securities don't qualify.
What about non-traded REITs? Are those 1031-eligible?
No. Non-traded REIT shares are still securities, even though they don't trade on an exchange. That does not make them like-kind to real property.
Are there any REITs that qualify as 1031 property?
Only in an unusual case: if a REIT held a direct real property interest and that interest, rather than REIT shares, was transferred to you. In practice this is extremely rare and impractical.
What is the alternative if I want REIT exposure after a 1031 exchange?
The DST-to-721 path: 1031 exchange into a DST, then contribute the DST interest to a REIT operating partnership through a 721 exchange.
If I can't 1031 exchange into a REIT, can I just buy REIT shares after my exchange?
Yes, but with after-tax money. To free up cash for REIT shares you would sell the replacement property, which triggers the gain you deferred in the 1031 exchange.