E
ditor’s note: This is the second part of a two‑part series on forced Section 721 UPREIT conversions. Part 1 highlighted the dangers of Delaware statutory trust (DST) offerings that automatically convert investors’ interests into REIT units at the end of the holding period, stripping them of the ability to choose when or whether to cash out or defer taxes.
Now we examine the opposite approach—fully optional UPREIT conversions—and explain why they are far superior and what investors should know before committing to any 721 exchange.
**Traditional DSTs with full liquidation**
1. **Cash liquidity and control**
A classic DST plans to sell the property after 5–10 years. When the sale occurs, investors receive cash proportional to their ownership. They can then decide to reinvest via a 1031 exchange, purchase another property outright, or take the cash and pay capital gains tax if that suits them. This gives complete control over the exit.
2. **Tax‑deferral via 1031**
The sale of a DST qualifies as a like‑kind exchange, allowing investors to roll gains into any suitable replacement property—another DST or a direct real‑estate purchase—maintaining tax deferral indefinitely. They also retain the option to pay tax and use the proceeds for other purposes.
3. **Simplicity and aligned interests**
The exit is a straightforward market sale, with an independent buyer setting the price. Sponsors are incentivized to maximize sale value, and investors receive net cash with no hidden fees or complex pricing structures.
**Optional UPREIT DSTs**
- **Investor choice**
At disposition, investors decide whether to exchange into the REIT or not. They can evaluate the REIT’s performance, debt levels, and market conditions before committing. If the REIT is attractive, they may opt in; otherwise, they can decline and proceed with a cash sale and optional 1031.
- **Timing and downside protection**
Because the conversion is optional, investors avoid being locked into a REIT during market downturns or when the REIT’s liquidity is constrained. They can take sale proceeds and reinvest elsewhere if conditions are unfavorable.
- **Preserved tax planning**
Declining the UPREIT keeps the 1031 option open. Choosing the UPREIT means sacrificing immediate 1031 flexibility for potential diversification, professional management, and estate‑planning benefits. The decision is made at exit, not predetermined.
**Conclusion**
Forced DST‑to‑UPREIT conversions remove control, create illiquidity, and limit tax‑planning options, exposing investors to significant risks and potential tax liabilities. Investors should favor structures that offer either full liquidation or, at minimum, a voluntary 721 option. Traditional DSTs provide clear, cash‑based exits with 1031 flexibility, while optional UPREIT DSTs combine those benefits with the choice to join a REIT when it makes sense.
Before investing, conduct thorough due diligence on the DST’s exit strategy. Review the target REIT’s SEC filings—10‑Q, 10‑K, and any tax‑protection agreements—to assess dividend coverage, leverage, debt maturities, and floating‑rate exposure. By prioritizing investor optionality and transparency, you can align your 1031 exchange with your financial goals and avoid being locked into an unfavorable long‑term vehicle.
