What changes on my K-1 and tax return after a 721 exchange?

The grantor statement becomes a partner's K-1, and the contribution itself never reaches Form 8824

While you held the trust interest you reported your share of its rent, expenses and depreciation as a direct owner, as described in DST tax return reporting. Once the interest is contributed, section 721(a) recognizes no gain or loss and you hold a partnership interest instead, so your income arrives on a Schedule K-1 from the operating partnership.

The Form 8824 instructions limit the form to 'each exchange of business or investment real property for real property of a like kind' and list partnership interests among property that is never real property for section 1031. A 721 contribution is neither, so it does not go on Form 8824. The Form 8824 you filed when you bought into the trust remains the record of your carried basis, and the 721 roll-up mechanics explain the contribution itself.

One filing can arise in the contribution year. Under Reg. section 1.707-3(c)(2), if the partnership transfers money or other consideration to you within two years of the contribution and you treat the transfers as other than a sale, you must disclose them under Reg. section 1.707-8, on Form 8275 or an attached statement. Operating cash flow distributions, as that regulation defines them, are excluded from the requirement.

Three items on the K-1 carry your 721 history: capital account, liabilities and the 704(c) gain

The Partner's Instructions for Schedule K-1 require item L to show your beginning and ending capital account on the tax-basis method, including capital contributed during the year. Because section 722 carries your adjusted basis in the trust interest over to the units, the contribution shows at that low carried figure, not at the value the REIT used to count your units.

Item K shows your share of partnership liabilities. Under section 752, an increase in that share counts as a contribution of money and a decrease as a distribution, so your basis in the units is the carried figure plus your share of debt, adjusted every year. The instructions note that basis can't be less than zero.

Item N is the line most DST investors have never seen. The instructions say the partnership will report 'your net unrecognized section 704(c) gain or loss both at the beginning and at the end' of its year, and that you are allocated it if you contributed property whose value exceeded its tax basis. That is your deferred gain, tracked by the partnership; it 'can use any reasonable method' to report it.

Depreciation follows the building's carried basis, and section 704(c) can leave you with less of it

Section 704(c)(1)(A) requires income, gain, loss and deduction on contributed property to be shared so as to account for the gap between its tax basis and its value. Under the traditional method in Reg. section 1.704-3(b), tax depreciation allocated to the other partners should match their book depreciation where possible, but total allocations cannot exceed the partnership's actual tax depreciation on the property, which the regulation calls the ceiling rule.

The regulation's own example shows the effect: the partnership can deduct only $400 of tax depreciation on contributed property, and it all goes to the partner who did not contribute it. Applied to a DST building with a low carried basis, your K-1 can show less depreciation against your share of rent than the trust's statement did, so more of each year's distribution may be taxable. The partnership may instead use curative or remedial allocations, which change the result; ask which method it uses.

Distributions reduce your basis, and once it reaches zero the cash is taxed as gain

Box 19 code A reports cash distributed to you, and code D reports deemed distributions from a decrease in your share of liabilities. Under section 731(a)(1), you recognize gain only to the extent money distributed exceeds the adjusted basis of your interest immediately before the distribution, and the instructions treat that excess as gain from the sale or exchange of your interest.

Hypothetical, round figures. You contributed a trust interest valued at $500,000 with a $150,000 carried basis, and item K allocates you $40,000 of partnership debt, so your basis in the units starts at $190,000. If, over the years, the distributions you receive exceed the income allocated to you by a cumulative $190,000, your basis reaches zero and every further dollar of cash is taxable gain that year. A redemption, covered in whether the REIT can refuse to redeem units, then taxes the rest. Have your CPA keep the basis worksheet from the first K-1 onward.