UpREITs: Tax-Driven Conversions for Property Owners

By Rich Murphy, Calkain Asset Management

One of the more under-discussed aspects of the REIT is how it can benefit a seller of real estate. By contributing a property to a REIT, you can achieve many of the same benefits associated with a 1031 Exchange including deferral of gain recognition, not to mention several other potential advantages.

One of the more under-discussed aspects of the REIT is how it can benefit a seller of real estate. By contributing a property to a REIT, you can achieve many of the same benefits associated with a 1031 Exchange including deferral of gain recognition, not to mention several other potential advantages. For the owner looking to monetize their investment in a tax-advantaged manner with the possibility of additional upside, this option deserves some additional examination.

Of the different types of REITs that exist, one sticks out as being particularly useful to sellers of real estate: the UPREIT. An UPREIT (Umbrella Partnership REIT) structure is one that has a REIT at the top of the structure and a partnership, which directly owns the real estate below it. Thus, the REIT simply owns an interest in the underlying partnership and not title to the actual properties themselves.

Some REITs, known as DOWNREITs, will acquire some properties outright, and also have interest in a lower-tier partnership, which directly owns properties. This article will focus on the UPREIT, however, it’s worth pointing out that the outcome for a contributor of property from a tax perspective is the same with an UPREIT as with a DOWNREIT. The major question is why the seemingly convoluted structure?

The mechanism by which these UPREITs acquire properties in their lower-tier partnership (the “OP” or operating partnership) is by contribution. That is to say, an owner contributes their property into the OP in return for an ownership interest in the partnership, usually referred to as “units”.

These units are typically transferable one for one with shares of the REIT’s stock. The number of units received for the property is negotiated in much the same way it would be if the property were being sold for cash. For example, if the property being contributed had a fair market value of $1 million and the stock of the REIT was trading for $25/share, then the contributor of the property would likely receive 40,000 units.

As a function of the tax rules at work governing such a transaction, this is in and of itself not a taxable event. It is not until the now partner in the OP converts his or her units into shares of REIT stock that he or she must recognize any gain.

In our next installment, we’ll look at benefits of such gain.