What is an UPREIT?
The UP in UPREIT means umbrella partnership. These REITs are often used in a 721 transfer (or 721 UPREIT exchange), which is similar to a 1031 exchange.
A 721 transfer starts with property and ends up with shares in a public REIT. An individual transfers property into a REIT in exchange for an ownership interest in the REIT's operating partnership (i.e., OP units). The main difference between a 721 and 1031 exchange is that you cannot do another exchange with a UPREIT. The next transaction will result in a taxable event.
The conversion of the property into OP units locks the exchange into a one-way street where further exchanges are prohibited. This is because OP units are not eligible for a 1031 exchange.
UPREIT Tax Implications
Whereas a 1031 exchange goes from the relinquished property into the replacement property to defer taxes, a 721 transfer goes from the relinquished property into OP units, which is not taxable.
Investors can still receive distributions by holding OP units. These distributions are on a pro-rata basis. When the investor is ready to liquidate, they sell their OP units or convert them into REIT shares. Both transactions trigger a taxable event.
In some cases, the acquiring operating partnership sells the contributed property, triggering a taxable event. This particular event is out of the investor's control and can happen unexpectedly. Investors in UPREITs must be prepared for this scenario and the tax consequences that come with it.
For those that hold their OP units until they pass away, their heirs will receive a step up in basis. This will allow heirs to convert their stepped-up OP units into REIT shares with little or no tax consequences. However, holding OP units for a long time can result in taxes due to gains.
Just as a 1031 exchange can be an involved process, so can a 721 UPREIT exchange. For that reason, it is best to work with an experienced realtor when considering a 721 UPREIT exchange.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
Investors who have sold real estate and executed a 1031 Exchange into a DST may execute future 1031 Exchanges and continue to defer taxable gains. Alternatively, a client may enter into a transaction pursuant to IRS Code Section 721 (also known as an UPREIT transaction). In an UPREIT transaction, Clients will receive, at the REIT Sponsor’s option, cash or OP units. OP units are units of an operating partnership that is wholly owned by a REIT. If the client receives OP units, he or she has exchanged into a security and therefore no longer owns real estate and cannot execute another 1031 Exchange out of the OP units and into other real estate. However, pursuant to IRS Code Section 721, the UPREIT transaction into the OP units may qualify as a tax-deferred exchange. The disposition of their interest in OP units will result in a taxable transaction, including the recognition of their deferred capital gain and any depreciation recapture. The client’s gain will only be recognized upon sale or disposition of the OP units.
There is no guarantee that an UPREIT transaction will occur. The option for this transaction is at the discretion of the REIT Sponsor. Some DSTs allow the client to choose whether to take OP Units or cash. Clients should consult the prospectus and their advisor regarding the specifics.
