An UPREIT can defer taxes and simplify ownership, but it also comes with meaningful trade-offs. The main disadvantages are that taxes are deferred, not eliminated; liquidity may be delayed or limited; you give up direct control of the property; and your risk can become tied to one REIT, management team, or property focus.
Tax Risks Are Often Deferred, Not Removed
A Section 721 exchange can postpone capital gains and depreciation recapture, but that does not mean the tax issue disappears. In many cases, taxes are recognized when OP units are converted into REIT shares or cash. A taxable event may also arise if the REIT sells the contributed property.
There are also ongoing tax considerations to weigh:
• Conversion risk: Converting OP units into REIT shares or cash can trigger capital gains tax and depreciation recapture.
• Distribution treatment: REIT distributions may be taxed as ordinary income, capital gains, or return of capital depending on how they are classified.
• Filing complexity: OP unitholders may have tax filing obligations in multiple states where the operating partnership does business.
For property owners focused on after-tax proceeds, the practical question is not whether tax can be deferred, but when and how it may return.
Liquidity May Not Be Immediate
UPREITs are often discussed as a way to move from illiquid real estate to a more liquid security. That can be true over time, but it may not help if you need cash right away.
Many UPREIT structures include a lock-up or holding period before OP units can be converted into REIT shares or redeemed for cash. Even after conversion, the value you realize depends on market pricing at the time of sale. If markets are weak, you could sell at a lower value than expected.
For owners selling highly appreciated property, that timing risk matters. Better liquidity is not the same as immediate liquidity.
You Give Up Control Over the Asset
Once you contribute property to an UPREIT, the REIT and its operating partnership control management, financing, leasing, redevelopment, and sale decisions. That can reduce day-to-day headaches, but it also means your preferences no longer drive the asset.
This loss of control can be especially important if you:
• Want a say in when the property is sold
• Prefer a certain financing strategy
• Have a long-term operating plan for the asset
• Do not agree with the REIT’s management decisions
Some structures also limit voting rights, leaving OP unit holders with little influence except on matters directly affecting holder rights.
Concentration Risk Can Still Be Real
An UPREIT may offer more diversification than owning a single property, but that does not automatically eliminate concentration risk. Some REITs focus heavily on one property type, one region, or one operating strategy. Your results may also depend heavily on one management team and one balance sheet.
That means your investment can remain concentrated in ways that are less visible than direct ownership. Before contributing property, review the REIT’s portfolio mix, debt profile, market exposure, and redemption terms carefully.
Frequently Asked Questions
Is an UPREIT a way to avoid taxes permanently?
No. An UPREIT generally defers taxes rather than eliminating them. Taxes may be triggered when OP units are converted into REIT shares or cash, or when other taxable events occur under the structure. Property owners should review timing, basis, and recapture issues with a qualified tax professional.
Why is liquidity considered a disadvantage if REIT shares can be sold?
Liquidity can be better than direct property ownership, but it may not be available when you need it. OP units are often subject to lock-up periods or conversion restrictions, and once shares are received, their sale value depends on market conditions at that time.
What is the biggest control issue in an UPREIT?
The biggest control issue is that you no longer direct the contributed property. After the transfer, the REIT makes decisions about operations, financing, leasing, and disposition. For owners used to hands-on decision-making, that shift can be one of the most significant drawbacks.
