An Umbrella Partnership Real Estate Investment Trust (UPREIT) is a structure that allows property owners to exchange their real estate for an interest in a partnership that is typically controlled by a Real Estate Investment Trust (REIT). The main appeal of an UPREIT is the tax deferral mechanism it offers on the transfer of property.
Here’s a simplified explanation of the UPREIT structure and its role within the real estate investment industry:
- Creation of the UPREIT: The UPREIT is created when a REIT forms a partnership, known as the Operating Partnership (OP), to hold its properties. This partnership is the umbrella over individual property investments.
- Contribution of Properties: Property owners contribute their real estate assets to the OP in exchange for units in the partnership, known as Operating Partnership Units (OP Units). These units are like shares in the REIT but remain at the partnership level.
- Tax Deferral: One of the main benefits of an UPREIT transaction is the ability to defer capital gains taxes that would normally arise from selling the property. This is because the exchange of real estate for OP Units is a tax-deferred event under IRS rules. The property owner only incurs tax if they convert their OP Units into REIT shares, which can be traded on the stock market.
- Management and Control: The REIT typically controls the operating partnership, allowing it to manage the properties within the UPREIT structure. This gives property owners who have exchanged their properties for OP Units a passive investment, with the potential for income distribution from the operations of the REIT.
- Liquidity: Property owners gain increased liquidity through the UPREIT. While the real estate itself is not liquid, the OP Units can be (subject to certain conditions) exchanged for publicly traded REIT shares, which can then be sold on the stock market.
- Estate Planning: UPREITs are also used for estate planning purposes. Property owners can pass the OP Units to heirs, who may then step up the basis of the property upon the original owner’s death, potentially reducing future capital gains tax liability.
UPREITs are an important vehicle in real estate investments, providing flexibility for property owners and contributing to the growth and liquidity of the REIT’s property portfolio. They offer a strategic way for individuals to diversify their holdings, gain exposure to a larger pool of real estate assets, and become part of a larger, professionally managed real estate investment structure.