Real Estate Investment Trusts (REITs) were introduced in 1960 to allow smaller investors access to income-producing real estate investments that were previously only attainable for the wealthy or large investors.
An Umbrella Real Estate Investment Trust (UPREIT) is a type of REIT where investors can trade a property that has appreciated for units in a REIT.
In 1960, the law under the Cigar Excise Tax Extension allowed for REITs to own and finance real estate investments. However, in 1986, the capabilities of a REIT were expanded with the Tax Reform Act of 1986, which gave the ability for a REIT to operate and manage investment properties as well.
What are REITs and UPREITs?
A REIT is a company formed to own, finance, and manage groups of income-producing real estate investments. These investments can be across sectors, or stay within one category, like office buildings or shopping centers.
An UPREIT is when a property owner partners with a REIT by exchanging ownership in their property that has appreciated for Operating Partnership units (OPs) in the REIT. The OP units can be converted to shares in the REIT, most of which are publicly traded. This partnership allows the exchanger the potential to benefit financially even after the property is exchanged.
The benefit to an UPREIT is that capital gains taxes are deferred when the property is exchanged into the REIT, called a 721 exchange. This type of exchange is governed under the tax shields for property to share exchanges by the IRS.
The capital gains taxes are deferred until one of three things happen:
- The exchanger sells the OP units
- The exchanger converts the OP units to shares in the REIT
- The acquiring OP sells the property
A 721 exchange is similar to a 1031 exchange, but instead of exchanging an investment property into a like-kind real estate investment like in a 1031 exchange, the property is exchanged into units of the REIT. Both have the benefit of capital gains tax deferment.