This article was updated on March 11, 2025.

One of the significant downsides of selling real estate property, especially property that has appreciated in value, is the associated taxable events. For selling owners who wish to defer or avoid paying capital gains tax, a Section 1031 like-kind exchange — a tax rule that allows sellers to defer capital gains taxes if they reinvest their proceeds into a similar property — can help reduce the tax burden.

However, it is not the only way. There is another alternative that property owners should be aware of called an UPREIT.

In this article, we will explore what an UPREIT is, why it is so beneficial, and in what circumstances real estate owners should consider it.

What is an UPREIT?

UPREIT stands for “umbrella partnership real estate investment trust.” It is an entity structure that allows selling property owners to convert their ownership of one or more of their real estate properties into an interest in a partnership. The interest then immediately becomes or can later be converted into a private or public security interest in REIT.

As such, UPREIT transactions provide an attractive tax-deferred exit strategy for owners of real estate who would recognize a significant taxable gain in a cash sale of a highly appreciated property.

In lay terms, the owner exchanges their ownership of the property, with its associated responsibilities, including taxes and maintenance, for shares in the operating partnership that owns and manages the property within a larger portfolio of real estate, otherwise known as a real estate investment trust, or “REIT.”

This defers the capital gains taxes in selling a property while allowing the owner to benefit from its appreciation by gaining an interest in a larger more diversified real estate portfolio.

How Does an UPREIT Transaction Work?

In an UPREIT transaction, a property owner contributes their property to the operating partnership (OP) of a REIT in exchange for units in the OP (OP units). They may exchange their property ownership for OP units, cash, or a mix of the two.

The transfer is generally nontaxable if appropriately structured. The contributing partners can continue to defer some or all the built-in gain in their contributed property until they exchange their partnership interests in the OP for shares in the REIT or the contributed property is sold by the OP in a taxable exchange.

What is the Difference Between an UPREIT and a Section 1031 Tax-Deferred Like-Kind Exchange?

An UPREIT allows investors to achieve the same deferral as in a Section 1031 exchange plus additional benefits. In a 1031 exchange, the property owner can defer their taxes by investing their capital gains from the sale of the property into another property.

In an UPREIT, the owner does not sell the property but instead exchanges their ownership of it for units in an operating partnership of a REIT, which then takes over the ownership and management of the property. This allows the owner to not only defer their taxes but also to:

• Eliminate the management hassles of owning real estate
• Diversify and expand their real estate portfolio
• Upgrade to institutional quality real estate
• Receive consistent quarterly income

It should also be noted that UPREIT transactions and 1031 exchanges are not mutually exclusive. The capital gains taxes remain deferred on the built-in gain as long as the OP holds the property, and the OP Unitholder holds the OP units. However, the OP can sell the property as part of a section 1031 exchange and avoid the recognition of gain to the OP Unit Holders that contributed to the property. In this case, the remaining built-in gain transfers over to the replacement property acquired in the 1031 exchange.

What are the Benefits of an UPREIT?

While tax deferral/avoidance may be the primary incentive to enter an UPREIT transaction, there are other substantial benefits for property owners completing this type of transaction, including:

• Diversifying your real estate holdings Increased share of depreciation deductions
• Allocation of qualified nonrecourse liabilities
• Ability to convert real estate into more marketable REIT securities
• Quarterly cash distributions from rental income
• Utilizing unrealized built-in-gains to generate increased earnings
• Professional management and expertise in capital markets
• Simplified estate planning
• Value maximization during property disposal
• Transaction structuring optionality

Diversifying Your Real Estate Holdings

You can diversify by converting an interest in one or more specific properties into an interest in a larger portfolio of properties. If you own multiple properties in multiple markets, this spreads your investment holdings and mitigates the impact if one property declines in value.

Increased Share of Depreciation Deductions

In the case of a newly acquired or developed real estate property funded from the REIT’s capital raising, OP Unitholders will receive a share of the depreciation deductions from the depreciable asset in accordance with their respective interests in the OP. These depreciation deductions will reduce the taxable income allocated to the OP Unitholders by the OP with respect to their OP units.

Allocations of Qualified Nonrecourse Liabilities

These allocations may allow you to contribute property encumbered with a liability without recognizing any gain — so long as the partners are allocated enough liabilities from the OP to cover its negative tax capital in the OP.

Ability to Convert Real Estate into More Marketable REIT Securities

Subject to certain restrictions, OP units can be converted on a one-for-one basis into shares of common stock of the REIT, i.e., OP units to REIT shares to cash.

This offers the ability to convert an illiquid asset like real estate into an equity interest that may afford the owner greater optionality, flexibility, and liquidity. While such a conversion may trigger recognition of a taxable gain, the flexibility allows the owner to unlock value and access capital as needed.

For example, the OP Unitholder can convert a portion of OP units into REIT shares over time instead of doing so all at once through the sale of a property. This, in turn, may help spread out and lessen the tax impact in any given year.

Quarterly Cash Distributions from Rental Income

OP Unitholders receive the same quarterly distribution payments as stockholders receive from their REIT shares. If desired, these distributions can be reinvested into REIT shares with the same value per share as OP units.

Utilizing Unrealized Built-in-Gains to Generate Increased Earnings

REIT shares and OP units can potentially increase in value and payout higher distributions. The OP Unitholder has the potential to recognize unrealized gains as dividends and share price increases, whereas unrealized gains are more difficult to tap into by typical property owners.

Professional Management and Expertise in Capital Markets

Often, the REIT’s management will have asset management and/or capital markets expertise, which may improve property performance, value, and access to debt financing.

Simplified Estate Planning

Estate planning may also become simpler as heirs no longer need to take over property management or facilitate sales. Heirs inherit OP units at a stepped-up tax basis upon the OP Unitholder’s death, and the units or converted REIT shares can be divided among several people in the desired proportions.

Value Maximization During Property Disposal

The property contributor can utilize the full equity value of their property to purchase an interest in an expanded portfolio of real estate assets while deferring gain recognition.

Transaction Structuring Optionality

Exiting property owners may elect to receive UPREIT transaction proceeds in the form of OP units, cash, or a mix of the two. This offers optionality to investors who have a shared interest in a property, as some may wish to continue to participate in the ownership of the assets for the long term as OP Unitholders, while others desire liquidity and would prefer to exit with cash.

When Should a Property Owner Choose an UPREIT?

An UPREIT transaction makes the most sense if a property owner is looking to defer the capital gains tax involved in selling a property and they want to accomplish one or more of the following:

• Not have to manage the property in question
• Diversify their real estate portfolio through investment in a group of properties
• Simplify their estate planning and streamline the process of sharing the value of the property with heirs
• Receive consistent quarterly cash distributions

An UPREIT transaction makes sense if a property owner is looking to defer capital gains tax on the sale of appreciated real estate and achieve other benefits, like diversification, consistent quarterly cashflow, or easier estate planning. Property owners contemplating using an UPREIT transaction generally plan on a long-term hold (e.g., five to seven years) of the OP units to make full use of the tax deferral.

Citrin Cooperman’s Real Estate Practice is here to support you throughout the life cycle of your deal. If a REIT structure seems like the right fit for you, please reach out to Stephen Lee at slee@citrincooperman.com or contact your Citrin Cooperman representative.