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What is an UPREIT? – Explained in Detail

Owning property can be a lucrative investment, but it also comes with a lot of responsibilities and hard work. However, there are alternative ways to increase your real estate investments and generate passive income. One...

Owning property can be a lucrative investment, but it also comes with a lot of responsibilities and hard work. However, there are alternative ways to increase your real estate investments and generate passive income. One such method is through an UPREIT.

Understanding UPREITs

An UPREIT, or umbrella partnership real estate investment trust, allows property owners to transfer a portion of their property to a real estate investment trust (REIT). By doing so, property owners become partial owners of the REIT and can delay capital gains on their commercial real estate.

UPREIT exchanges typically involve property owners contributing their real estate (commercial or residential) to the operating partnership (OP) or subsidiary of the REIT. In return, they receive REIT OP units, which can later be converted into REIT shares. This process allows property owners to diversify their investment portfolio.

how upreit works Image Source: Royal Oak Realty Trust

Diversifying one's portfolio can lead to greater liquidity in the future. Property owners participating in UPREIT exchanges can defer capital gains on appreciated property until they decide to sell the OP units.

Examples of UPREITs

To further illustrate how UPREITs work, let's take a look at Vanguard, Fidelity, and Lamar UPREITs. These investment agencies allow property owners to contribute their properties and avoid capital gains tax. By receiving limited partnership units, property owners can enjoy passive income while minimizing tax liabilities.

By partnering with umbrella organizations like Vanguard, Fidelity, or Lamar, property owners can hand over their properties when they are ready to sell, thereby avoiding high taxes and still earning income.

Advantages of UPREITs

There are several advantages to investing in UPREITs:

  1. Tax advantages: UPREITs allow property owners to defer capital gains tax, which is particularly beneficial for properties with a low tax basis.

  2. Long-term passive income: By holding OP units, property owners receive a steady stream of passive income from the REIT over an extended period.

  3. Access to the Section 721 exchange: Unlike other investments, UPREITs provide access to the Section 721 exchange, offering additional flexibility and tax advantages.

  4. Future liquidity: When property owners convert their OP units to REIT shares, they gain control over the timeline for future liquidity. However, exercising control can trigger capital gains.

  5. Portfolio diversity: Holding shares in a REIT allows investors to have a more diverse portfolio, including a mix of tenants, geographies, ages, and more.

  6. Simplified estate management: In the event of the property owner's passing, dividing OP units is often easier than dividing single properties, simplifying estate management.

Disadvantages of UPREITs

While UPREITs offer several benefits, it's essential to consider the potential disadvantages before investing:

  1. Complex tax filing: Having dividends distributed to all shareholders means an increased tax filing workload. It's advised to seek the assistance of a knowledgeable tax advisor to ensure compliance.

  2. One-time tax deferral: Although UPREITs allow for the deferral of capital gain taxes, it's only a one-time deferral. Subsequent gains may still be taxable.

  3. Finding buyers may take time: In some cases, finding buyers for UPREITs can be time-consuming, creating a potential disadvantage when compared to other investment options.

  4. Limited control: Once property owners enter into an UPREIT, they may relinquish a significant amount of control over property management.

UPREIT Requirements

If you're considering joining an UPREIT, there are several specific requirements to meet:

  • Familiarize yourself with accounting and tax codes that govern UPREITs.
  • IRC Section 721 tax laws guide the structure of UPREITs, outlining how property and share exchanges are treated for tax purposes.
  • UPREITs must adhere to standards that stipulate real estate property and financing must constitute more than 90% of their business.
  • While UPREITs follow similar investment strategies as REITs, they often focus on specific real estate niches.

UPREIT vs. DownREIT: Understanding the Difference

Although UPREITs and DownREITs are both types of REITs, there are distinct differences between the two. DownREITs involve a joint partnership between the REIT and property owners, while UPREITs do not require outright real estate ownership.

For those looking to diversify their investment portfolios without acquiring real estate property, UPREITs offer the opportunity to have real estate shares. DownREIT exchanges are based on the market value of the property held by the REIT and the owner, often resulting in better returns compared to UPREITs.

Who Should Consider UPREITs?

UPREITs are ideal for individuals looking to diversify their investment portfolios and minimize the risk of losses. Property owners with a single commercial property or a few properties can benefit the most from UPREITs by gaining access to a more extensive REIT portfolio.

Partnerships, families looking to sell jointly owned properties, and business owners seeking to lease their properties while mitigating risk are also potential beneficiaries of UPREITs. If you believe an UPREIT aligns with your investment objectives, it's worth exploring REIT options such as Fidelity, Lamar, and Vanguard.

Frequently Asked Questions about UPREITs

  1. Are UPREITs complicated?

UPREITs can be intricate, but they don't have to be. By understanding the basics and seeking professional guidance, you can confidently navigate the world of UPREITs.

  1. Can UPREITs provide tax advantages?

Yes, one of the primary benefits of UPREITs is the ability to defer capital gains tax on real estate properties with low tax bases.

  1. How long does it take to find a buyer in an UPREIT?

Finding a buyer for UPREIT units can vary in time depending on market conditions and demand. While it may take some time, the potential long-term benefits of an UPREIT can outweigh the wait.

Investing in real estate through an UPREIT can be a smart option for individuals looking to diversify their investment portfolios and generate long-term passive income. By understanding the advantages, disadvantages, and requirements of UPREITs, you can make informed investment decisions that align with your financial goals.