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UPREIT stands for Umbrella Partnership Real Estate Investment Trust.
UPREITs Avoid Capital Gains Taxes
These were started in 1992 by "creative" (per Ralph L. Block) investment bankers. Basically, they allow people who allow people who already own property to form them into REITs, without having to immedately pay capital gains taxes on them.
The timing was good, because 1993-1994 saw a boom in Initial Public Offerings of formerly private real estate companies making themselves publicly owned and traded REITs.
UPREITs Provide Important Benefits to Direct Owners of Real Estate Property Who Wish to Get Out From Under the Responsiblity, Without Paying Out a Fortune in Capital Gains Taxes
If the existing owners of commercial real estate properties simply sold them to the new REIT entity, that transaction would be a taxable event that would create a large tax bill for them (assuming they'd held the property long enough to have seen a large appreciation in its fair market value.)
Therefore, the existing owners of the property and the operators of a newly-formed REIT form a limited partnership termed the Operating Partnership. Their interests in the Operating Partnership (OP) are called units.
For their units, the existing owners contribute their property, and the REIT managers contribute the cash they raised from their IPO.
Normally, the REIT is the majority or controlling partner, and the general partner which does the work of managing the properties. The former owners are limited partners. They share in the profits
of the OP based on their number of units.
Members of the REIT management are also limited partners in the Operating Partnership.
This UPREIT Arrangement Allows Commercial Property Owners to Receive Shares That are More Liquid and Diversified
This "like-kind" exchange of property ownership for units in a real estate partnership is not immediately taxable, pursuant to IRC section 721, so the owners have deferred paying capital gains taxes. Yet they receive current income without the work of having to actually manage the properties themselves.
They receive dividend distributions from the real estate investment REIT and can vote, just like ordinary shareholders.
After a time, usually one year, these former owners can trade in (tender) their OP units for either cash or REIT shares. This is a taxable event, so they can spread this out as long as they like. If they die before tendering their units in the OP, their heirs can tender the Operating Partnership units for cash or REIT shares without paying income taxes.
Therefore, an UPREIT is a good thing for direct property owners looking to retire on a good income and to plan their estates to benefit their heirs.
Next: How DownREITs can improve upon UPREITs.
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