If you’re contemplating retirement or want to transfer your wealth to future generations, estate planning is integral to your long-term strategy. And if investment real estate is part of that wealth generation, contributing your property to an Umbrella Partnership Real Estate Investment Trust or UPREIT can help you achieve current investment objectives while passing along potential tax advantages to your heirs.
What is an UPREIT?
An UPREIT is a legal structure outlined in the 26 U.S. Code § 721—“Nonrecognition of Gain or Loss on Contribution.” It allows you to contribute real estate holdings in exchange for Operating Partnership (OP) units. You can then convert those units to shares in an underlying public or private real estate investment trust (REIT) or for cash.
Potential UPREIT benefits can include diversification, deferred capital gains taxes, and depreciation recapture payments. A 721 exchange can also offer the following advantages to your estate planning efforts:
Stepped-Up Basis
When you die, your heirs inherit the UPREIT OP units at fair market value on the date of death, rather than the asset’s original purchase price. This is known as a stepped-up basis, and it can potentially reduce or even eliminate capital gains tax liability on pre-inheritance appreciation.
If your heirs decide to sell the OP units, they would only pay taxes on capital gains occurring after the inheritance date rather than an entire gain from your original purchase. Large estates may still be subject to estate taxes if the total estate value exceeds federal or state exemption thresholds.
Simplified Administration
Investment properties in your estate can create complications. Each property has to be managed, appraised and eventually sold. However, exchanging those properties for Operating Units with a 721 exchange can streamline matters. The process replaces several assets with one.
While OP units are generally easier to transfer than real estate, they are not immediately liquid and may be subject to conversion restrictions before they can be exchanged for REIT shares or cash. Additionally, heirs should consider potential tax implications when converting OP units.
Income Flow
If your heirs decide not to sell the OP units when you die, they can receive cash flow from the underlying REIT as dividends. This could provide a steady income stream without the burden of directly managing real estate properties.
UPREIT Caveats
There are some factors to consider when using an UPREIT for estate planning.
- Lock-up periods: Some UPREITS might have a lock-up period. This is a timeframe where investors can’t sell or exchange their OP units for cash or REIT stock. It allows the REIT to integrate the contributed property but also means you or your heirs might not benefit from immediate liquidity.
- Market conditions: UPREIT investments can be exposed to high volatility, depending on the underlying REIT’s performance. Market movements, management decisions, and property appraisals can impact the value of the REIT shares.
- Tax implications: Once you (or your heirs) convert OP units to REIT shares or cash, you lose the benefit of tax deferrals. This could mean tax liabilities and limited control over the timing of capital gains recognition.
A Different Estate Planning Strategy
If you’re trying to figure out how to pass on real estate to your heirs, an UPREIT could be a potential solution. The process could help reduce capital gains taxes and simplify administration.
As UPREIT contributions can be complex, it’s important to consult with your tax advisor and estate planner if you’re considering contributing your investment real estate to an UPREIT for estate planning purposes. Understanding the potential benefits and challenges of the process can help ensure that your heirs receive the most value from your assets.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
