UPREIT: Benefits and Qualifications in Real Estate Investing

An UPREIT (umbrella partnership real estate investment trust) is a REIT structure that lets property owners contribute real estate to a REIT in exchange for partnership units rather than selling the property outright. These property-for-unit exchanges are generally governed by Internal Revenue Code Section 721 and typically defer immediate recognition of capital gains.

How an UPREIT works

Property owners transfer real estate to the REIT’s operating partnership and receive partnership units (often called OP units) or similar units in return.
Because the transfer is generally treated under IRC Section 721, the contributor usually does not recognize taxable gain at the time of the exchange, effectively deferring capital gains tax until the units are sold or converted.
UPREITs usually allow unit holders to:
Hold units for a period before converting to public REIT shares,
Convert units to REIT shares immediately (if allowed), or
Receive cash after satisfying any holding or conversion requirements specified in the UPREIT agreement.
Once contributed, the REIT owns and manages the property; UPREIT managers handle property operations, financing, and portfolio decisions.

Key benefits

Tax deferral: Section 721 exchanges generally defer immediate capital gains taxes that would result from a cash sale.
Liquidity and diversification: Converting property into units can provide exposure to a diversified real estate portfolio and potentially easier liquidity (especially in publicly traded UPREITs) compared with holding a single property.
Estate planning: Some property owners use UPREITs as part of estate planning to defer or manage tax consequences.
Alternative to direct sale: Owners who prefer not to sell their property outright can obtain value without an immediate taxable event.

Requirements and qualifications

UPREITs are REITs and must satisfy standard REIT tax and operational rules (e.g., rules under IRC Sections 856–859), including requirements about income and asset composition.
Generally, more than 90% of a REIT’s assets and income must be related to real estate for pass-through tax treatment to apply.
The UPREIT structure specifically permits Section 721-style contributions; any REIT that accepts property contributions under Section 721 can be considered an UPREIT.

UPREIT vs. 1031 exchanges and DownREITs

Section 1031 (like-kind) exchanges let owners defer tax by trading one property for another like-kind property — they do not permit exchanging property for partnership units. Because 1031 requires a like-kind property swap, it cannot be used to transfer ownership into an UPREIT.
DownREITs are a related variant in which property owners contribute assets through a joint-venture arrangement with the REIT. Unit valuation and returns in a DownREIT are often tied to the joint-venture valuation rather than a direct unit-for-property conversion.

Risks and special considerations

Management complexity: UPREIT structures and Section 721 provisions can add administrative and governance complexity for both contributors and managers.
Valuation and volatility: Unit values and REIT share prices fluctuate with property valuations, financing decisions, and market conditions.
Tax after deferral: While the initial transfer often avoids immediate tax, taxes may be due when units are sold or converted, and distributions from REITs are taxed under standard REIT rules.
Liquidity varies: Public UPREITs generally offer greater liquidity than private UPREITs; conversion terms, holding periods, and transfer restrictions can limit immediate cash access.

Conclusion

UPREITs provide a mechanism for property owners to exchange real estate for partnership units in a REIT, offering potential tax deferral, diversification, and liquidity benefits. They must meet standard REIT requirements and follow Section 721 rules, and they carry specific management, tax, and liquidity considerations that owners should evaluate before contributing property.