Q: How does an UPREIT create flexibility for unitholders?

A: An UPREIT (Umbrella Partnership Real Estate Investment Trust) offers unitholders a unique advantage by providing flexibility in managing real estate investments. If you’re wondering how this flexibility benefits you or your heirs, or what you can do with your shares, this post should provide some key insights.

An UPREIT allows real estate owners to contribute their properties into a partnership in exchange for operating partnership units (OP Units). These OP Units are then convertible into REIT shares. This structure can defer capital gains and depreciation recapture taxes that would typically be due upon selling the property. In addition, it provides greater liquidity and diversification compared to holding a single property, as the investor’s stake is now part of a diversified portfolio managed by the REIT.

Additionally, converting OP Units into REIT shares provides greater liquidity, as REIT shares can be sold on the market, unlike direct real estate holdings which can be harder to sell quickly.

The ability to convert and sell OP Units at different times allows unitholders to spread their tax burden over multiple years, potentially avoiding high tax rates in any given year. Additionally, by holding units until retirement, a unitholder might convert units at a time when they’re in a lower tax bracket, further minimizing tax liabilities.  Most unitholders hold their shares until passed along to their heirs, this allows for the potential for basis step-up and the ultimate in tax savings.

Here are several UPREIT holders can leverage their OP Units:

1.       Defer Capital Gains Tax By holding OP Units instead of immediately converting them into REIT shares, unitholders can defer the recognition of capital gains tax. This is particularly useful if the sale of the real estate would trigger a large tax liability. Instead, taxes are only due when the OP Units are converted into REIT shares and sold.

2.       Partial Liquidation Over Time Unitholders aren’t required to convert all their OP Units at once. They can choose to convert and sell some of their units now, and others later. This approach allows them to control the timing of tax recognition, potentially spreading it over several years to avoid pushing themselves into a higher tax bracket in any one year.

3.       Heirs Can Inherit Without Immediate Taxation When UPREIT units are passed to heirs, they receive a "step-up" in basis, meaning that the capital gains tax due on the eventual sale is minimized or eliminated for the heirs. The flexibility of an UPREIT also allows heirs to choose when to convert the OP Units into REIT shares, giving them control over their tax situation.

4.       Split Units into Two Different Trusts When the property interest is converted to the UPREIT shares, those shares can be split into two different trusts. One trust can be set up as a 1014 trust (step-up in basis) and a 1015 trust (no-step up but designed to minimize estate tax).  The heirs can then liquidate the shares that receive a step up without being forced to liquidate the entire property; free everyone up to make their own decisions fitting their own circumstances.

5.       Charitable Contributions UPREIT unitholders can also donate their units to charity. In doing so, they can potentially avoid paying capital gains tax on the appreciated value of the real estate while receiving a charitable deduction for the donation. This strategy provides both tax benefits and the opportunity to support a charitable cause.

6.       Tax-Efficient Estate Planning For estate planning, an UPREIT provides several options. Besides the step-up in basis for heirs, unitholders can also use the flexibility of the units to make strategic conversions over time, reducing the size of the taxable estate by converting and gifting shares, while still benefiting from any appreciation in value.

An UPREIT provides a wide range of benefits for real estate investors, particularly when it comes to managing tax liabilities and providing flexibility in estate and charitable planning. By allowing for deferred taxation, partial liquidation, and a step-up in basis for heirs, UPREIT units offer real estate investors control over how and when they recognize gains, making them a valuable tool for building long-term wealth.