An avenue some investors use to turn appreciated real estate into passive income is by exchanging the value of the property into shares in an Umbrella Partnership Real Estate Investment Trust (UPREIT) instead of selling it outright.
Instead of selling, the property owner exchanges it into an UPREIT through a Section 721 exchange. This gives the investor the potential for earning passive income and also has some tax benefits. While UPREITs aren’t right for many investors, they are worth looking into for some.
First, it is important to understand UPREITs and how they bring in capital.
In an UPREIT, the trust generates capital by managing the properties in the portfolio, usually by renting or selling them. They have acquired the properties from investors with appreciating real estate that want to exchange their property for units in the trust.
Some reasons that some investors choose UPREITs include:
- In many instances, shares can be bought and sold like stocks
- The potential to be more consistent than other investments
- Investors can hold shares of a portfolio of properties, not just their own
- As a passive investor, there are no day-to-day responsibilities
Income From Holding Shares In An UPREIT
One way to get potential income from being a partner in an UPREIT is by exchanging their units in the trust into shares that they will sell and cash out, if the UPREIT is increasing in value.
Most UPREIT’s are public and traded on major stock exchanges, and are structured like a corporation. In a publicly-traded UPREIT, shares are sold to the public in an initial public offering (IPO). When an investor sells their shares and the UPREIT has been profitable, they will earn the difference between the value of their original share and the value of the share when they sell.
Private UPREITs traditionally have much less fluctuation than publicly traded trusts because they are not traded daily. They are also only available to accredited investors, limiting the access most investors have to them. Private UPREITs are also subject to less SEC regulations than publicly traded UPREITs.
Besides selling shares in an UPREIT, investors can also make an income from the dividends from a profitable UPREIT. If the UPREIT is profitable, this has the potential to be a steady income stream.
While it is not income, there are potential tax benefits to exchanging a property into an UPREIT. Most properties transferred into an UPREIT will have deferred capital gains taxes. The deferred capital gains taxes come due when the shareholder sells their units of the UPREIT, or when the trust sells the property.
If you are considering an UPREIT, it is best to consult with a professional knowledgeable in REITs to look at all the variables.