UPREIT Program FAQ
What is a REIT?
What is an UPREIT?
What is an UPREIT transaction?
What are the benefits of contributing my property to an UPREIT?
How long are capital gains taxes deferred?
How is owning OP Units similar to owning shares of stock?
How does OP Unit ownership differ from REIT ownership?
For whom do UPREIT transactions make the most sense?
What are the drawbacks to the asset owner in an UPREIT transaction?
If I have debt on my property, can the mortgage be assumed in an UPREIT transaction?
How are partnership debts allocated?
Can I execute an UPREIT transaction where I receive part units and part cash?
Should I seek professional legal/tax advice before entering into an UPREIT transaction?
What is a REIT?
A Real Estate Investment Trust (REIT) is an entity that combines the capital of many investors to acquire, manage, develop and/or provide financing for all forms of real estate. A REIT has similarities to a mutual fund in that investors obtain the benefit of a diversified portfolio of real estate, which is professionally managed. If REITs comply with certain guidelines, they do not pay tax at the corporate level. Among these guidelines is that REITs must pay out at least 90% of their taxable income as dividends to shareholders.
What is an UPREIT?
An Umbrella Partnership Real Estate Investment Trust (UPREIT) refers to an entity structure that allows selling property owners the ability to convert their equity ownership in real estate properties into an equity interest in a REIT’s subsidiary on a tax deferred basis.
In a typical UPREIT structure‚ all REIT properties are purchased and owned directly or indirectly by its “umbrella partnership” (also referred to as an operating partnership (OP)). The properties are operated and managed within the OP, of which the REIT serves as the sole general partner as well as a significant limited partner. In the case of our structure‚ Four Springs Capital Trust is the REIT and the sole general partner of Four Springs Capital Trust Operating Partnership, L.P.‚ which is the operating partnership of the REIT.
What is an UPREIT transaction?
We An UPREIT transaction is similar to a sale of real estate for cash. In an UPREIT transaction, an owner of real estate contributes their interest in real estate to the operating partnership in exchange for OP Units instead of cash. In addition, in an UPREIT transaction the seller is allocated a certain dollar amount of debt of the operating partnership for tax purposes. See “How are partnership debts allocated?” below.
What are the benefits of contributing my property to an UPREIT?
- Tax Deferral: It provides a practical tax deferred exit strategy to property owners that carry significant capital gains in their properties due to a low tax basis.
- Increased Liquidity: OP Units can be converted into REIT Shares which may be listed on a national securities exchange and sold for cash while real estate may have less liquidity.
- Diversification: Increased diversification as the seller is exchanging an interest in a single property or small portfolio for an interest in a much more diverse set of assets. With Four Springs Capital Trust, there is diversification by not only tenant, industry, geography but also property type (industrial, medical office and retail).
- Tax Planning Flexibility: Improved tax planning as the seller can choose when to convert the OP Units to REIT shares or cash when the timing is most convenient, which enhances a seller’s tax planning. A seller may convert their OP Units over several tax periods and spread out their tax liability as only the pro rata portion of a seller’s tax liability will be triggered upon conversion.
- Durable Income: Monthly/Quarterly dividend distributions that can provide similar cash flow to the sold asset(s). The durability of the distributions from a REIT may be greater than from a single property or a small portfolio due to the diversified nature of a REIT’s portfolio of properties.
- Estate Planning Flexibility: The seller can divide OP Units among their beneficiaries, and each beneficiary can make their own decision to hold such OP Units or sell them for liquidity. In addition, the heirs inheriting the OP Units will receive a stepped-up cost basis in the units equal to the value at the time of the owner’s passing or an alternate valuation date.
- Passive Management: Property management responsibilities will no longer be a concern as the REIT takes over management of the property.
- Financial Flexibility: In addition to converting the OP Units into REIT shares and selling the REIT shares, OP Units could be used as collateral for a loan, further improving access to capital by the seller.
How long are capital gains taxes deferred?
The capital gain taxes remain deferred as long as the UPREIT retains the asset(s) and the Unit Holder holds the OP Units. In other words, a Unit Holder will incur capital gains taxes if: (a) the Unit Holder exchanges the OP Units for REIT shares; (b) the Unit Holder redeems their OP Units for cash; or (c) the subject property is sold by the operating partnership. In many cases, however, the operating partnership will sell the property as part of a 1031 exchange and avoid triggering the gain on the contributed property.
How is owning OP Units similar to owning shares of stock?
OP Units have similar economic characteristics as REIT shares. In addition, an OP Unit holder may receive distributions that are similar or equal to the dividends paid on REIT shares.
How does OP Unit ownership differ from REIT ownership?
The distribution that the OP Unit holder receives is viewed as a percentage of the income generated by the operating partnership. Given that the UPREIT owns and manages properties in multiple states, a Unit Holder may have income tax filing requirements in each state.
Also, OP Unit Holders have more limited voting rights that REIT shareholders since Unit Holders own an interest in the partnership and not in the REIT.
For whom do UPREIT transactions make the most sense?
For an offering of OP Units to be exempt from federal securities law, the owner must be an accredited investor. To qualify as an accredited investor, a property owner must satisfy one of four criteria:
- an individual with gross income exceeding $200,000 in each of the two most recent years or joint income with a spouse or partner exceeding $300,000 USD for those years and a reasonable expectation of the same income level in the current year, or
- a person whose individual net worth, or joint net worth with that person’s spouse or partner, exceeds $1,000,000, excluding the person’s primary residence, or
- a trust or similar entity having assets exceeding $5,000,000.
There are many reasons why a property owner might want to pursue an UPREIT transaction. Several of the more common motivating factors that would make a property owner a good candidate for an UPREIT transaction are listed below:
- They want to sell an appreciated asset with a very low cost basis, while deferring the capital gains.
- They are looking for a professional operator to take over management of their asset.
- They are interested in receiving a dependable income stream.
- They want to reduce their investment risk. The investor benefits from a diversified portfolio of institutional quality real estate assets and is no longer reliant on one or a few assets for cash flow and capital appreciation.
- They are looking to simplify their succession planning by passing down easily divisible OP Units to their heirs.
What are the drawbacks to the asset owner in an UPREIT transaction?
Unlike a 1031 exchange, once a property owner takes OP Units in return for selling an asset, they can not exchange that Unit back into an equity interest in an individual property. UPREIT units can only be converted into shares of the REIT, which creates a taxable event. However, unit conversion is at the owner’s discretion; giving the holder control over the timing the conversions and tax payments.
Also, OP Unit Holders have more limited voting rights than REIT shareholders since Unit Holders own an interest in the partnership and not in the REIT.
If I have debt on my property, can the mortgage be assumed in an UPREIT transaction?
Depending on how the note is written, in many cases the mortgage on a property that an owner wishes to sell to the operating partnership is assumable. If the mortgage debt has been outstanding for at least two years at the time of the transaction, then the mortgage debt generally will constitute a qualified liability and not be regarded as a “disguised sale”. On the other hand, if the mortgage debt was incurred in the prior two years, then its characterization for disguised sale purposes may depend on how the borrowed funds were used. If the proceeds were used to invest in the property or to refinance debt on the property, then the mortgage debt generally will be a qualified liability and not considered a disguised sale.
How are partnership debts allocated?
As a partner in the Operating Partnership, an OP Unitholder will receive an allocation, for income tax purposes, of the liabilities of the Operating Partnership. An OP Unitholder’s adjusted tax basis in his or her OP Units will be increased by the amount of such allocation. Among other things, an increased tax basis from an allocation of liabilities may enhance an OP Unitholder’s ability to (i) receive cash distributions in excess of earnings on a tax-deferred basis and (ii) absorb and use net losses, if any, generated by the Operating Partnership.
Can I execute an UPREIT transaction where I receive part units and part cash?
Four Springs Capital can structure an UPREIT transaction that fits the financial/tax needs of most clients. However, to the extent that a seller receives cash as a portion of the consideration, certain federal and state tax liabilities may be triggered.
Should I seek professional legal/tax advice before entering into an UPREIT transaction?
Absolutely! Every individual’s legal, financial and tax situation is unique, and the tax issues related to UPREIT transactions can be complex. Asset owners are encouraged to obtain expert tax and legal advice before finalizing the sale of property to an UPREIT.