TAX · JULY 2026 · STRATEGY
The step-up at death for OP units, and the state tax layer
OP units held at death receive a Section 1014 basis step-up that eliminates deferred gain, but state sourcing rules can outlive the federal fix.
721 Hub · July 8, 2026
What happens to the deferred gain in a if the investor never sells or converts? The long-term outcome mirrors a continued 1031 program: the basis step-up at death extinguishes the embedded gain. The federal answer, however, is not always the state answer.
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The parallel to swap-til-you-drop
Under IRC Section 1014, the basis of property held at death is stepped up to fair market value as of the date of death. OP units are property; the step-up applies. An investor who contributes appreciated property to an UPREIT, holds the OP units through retirement, and dies still holding the units passes those units to heirs at full fair-market-value basis. The embedded gain is eliminated, and the heirs can convert to REIT shares and sell with little or no additional federal tax.
This parallel is the structural reason the UPREIT path is sometimes called the institutional version of swap-til-you-drop. The investor swaps real property for an OP unit, holds, and dies. The outcome is the same: deferred gain extinguished at death.
State tax: a layer the federal mechanics do not address
Section 721 is a federal provision. State tax treatment of a contribution is determined state by state. Most states with an income tax conform to the federal nonrecognition rule for partnership contributions, but the conformity is not universal.
California is worth flagging. California generally conforms to Section 721 at the moment of contribution, but the Franchise Tax Board's source-of-income rules will continue to apply to the underlying real estate. If the contributed property is California real estate, distributions and gain from the operating partnership that are attributable to that property remain California-source income to the contributor and to the contributor's heirs, regardless of where they reside. The federal step-up at death does not automatically resolve the state-level sourcing question. Investors contributing California real estate to a UPREIT should review their state-tax exposure with counsel before signing; out-of-state contributions are usually cleaner.
When the 721 path is most tax-efficient
A 721 contribution is most tax-efficient when the investor intends to hold the OP units long-term, ideally through death, so the Section 1014 step-up eliminates the deferred gain; when the investor does not need the depreciation pass-through of direct ownership; when the contributed property's debt does not trigger boot under Section 752 (debt relief in excess of basis); and when the sponsor's lock-up covenant and conversion provisions align with the investor's holding timeline.
It is most problematic when the investor expects to need liquidity inside two to five years, when embedded debt would generate boot, or when the conversion provisions accelerate recognition on a timeline the investor cannot control. Before signing, an investor should confirm in writing the carryover basis calculation, the hold-period covenant, the conversion mechanics and their tax treatment, the expected allocation of taxable income relative to cash distributions, and state-level conformity for both the investor's residence and the property's situs.
The full lifecycle is indexed in the Section 721 UPREIT tax treatment overview.
Figures and examples are general and for educational purposes only. Section 721 contributions raise individual tax questions that require coordination with a qualified tax advisor.