Investors have numerous options to consider when planning how their legacy will be passed down to their heirs. Of course, each individual has different priorities, such as tax efficiency, streamlined transfers, or wealth preservation. There is one approach that can address all these needs: the umbrella partnership real estate investment trusts (UPREIT). These structures allow property owners to exchange real estate holdings for operating partnership (OP) units, offering unique advantages for various types of investors.
Below, Realized 1031 shares insights on using UPREITs for estate planning and wealth transfer.
UPREITs are investment vehicles that own underlying properties. A REIT has the controlling interest and handles the management and operations of the assets. Investors serve as limited partners and own OP units, earning distributions based on the number of units they possess. Through a 721 exchange, property owners can contribute their real estate to a UPREIT and receive the equivalent OP units. The IRS doesn’t recognize gains or losses in this type of exchange, resulting in tax deferral.
While OP units can be held indefinitely, investors can convert them into REIT shares if they need liquid cash. The shares can then be traded or sold on public trading markets, which is a taxable event.
Given the structure of UPREITs, they are able to provide advantages that address key concerns for those who are planning how their legacy will continue.
For many investors nearing retirement or those who are already retired, their properties have appreciated in value over the years. Selling them the traditional way would result in substantial capital gains that could reduce their retirement funds. The tax-deferral benefits of 721 exchanges, however, allow investors to delay tax liability and keep more of their capital working for them.
Upon the passing of an investor, any remaining OP units undergo a step-up in basis. This means that their cost basis resets to their fair market value at the time of death, effectively eliminating capital gains taxes. This tax relief will be felt by heirs, of course, but it also provides you (the investor) peace of mind knowing that you’re not burdening your loved ones with tax.
Compared to direct property ownership, wealth transfer is much easier through OP units. Valuation can be more streamlined, and you won’t need to create shared-ownership schemes if one asset is to be distributed to multiple beneficiaries.
Here are specific approaches you can use during UPREIT estate planning.
One practice that doesn’t automatically trigger tax liability is gifting OP units to your heirs. You can avoid the complexities of title transfers through this method. However, your OP units won’t encounter a step-up in basis with this strategy. Instead, the basis carries over.
By contributing property to an UPREIT in exchange for OP Units and then gifting those units to heirs, an investor can “freeze” the current value of their estate for tax purposes. Any future appreciation of the units occurs outside of the taxable estate, potentially reducing estate taxes.
You can also place your OP units into various trust structures. This strategy helps optimize tax efficiency while controlling the distribution of assets. Plus, trusts can help shield your OP units from creditors, ensuring that your wealth is preserved for your heirs.
There are two main considerations for estate planning using UPREITs. First, you lose control of your assets upon contribution. This is usually suitable for those who no longer want direct control over their assets. However, if you still want to remain in control, other tax deferral strategies like 1031 exchanges may be more suitable.
The other major consideration is that converting OP units to REIT shares is a taxable event. As such, liquidating your investment during your lifetime must be planned carefully to avoid getting a huge tax hit.
UPREITs help streamline estate planning and wealth transfer due to the nature of OP units. Aside from tax-deferral benefits, UPREITs allow you to neatly divide units for each heir, and the step-up in basis after your passing can help reduce tax burden. Overall, UPREITs can serve as a cornerstone of your estate planning strategy.
Sources:
https://www.rocketmortgage.com/learn/step-up-in-basis