What is an UPREIT? – Defined & Explained

Most people would agree that owning property is an excellent investment. You can earn income from your commercial business or by renting it out, but it requires a lot of work to keep a property running and in good condition.

Besides owning and managing property, there are other ways to increase your investments in your real estate, such as an UPREIT.

If you own a property (or several) and want to earn more passive income and diversify your investment portfolio, an UPREIT might be a good option.

Keep reading to learn everything there is to know about UPREITs and how they work.

Umbrella Partnership Real Estate Trust Definition

An UPREIT, or umbrella partnership real estate investment trust, is where a property owner gives a portion of their property to a real estate investment trust (REIT).

UPREITs provide a piece of their property to have some ownership in the REIT. It allows real estate owners to delay capital gains on commercial real estate.

How Does an UPREIT Work?

In UPREIT exchanges, a property owner will usually contribute their real estate (commercial or residential) to the operating partnership (OP) or subsidiary of the REIT.

They do this in exchange for REIT OP units. The OP units convert to REIT shares, allowing the property owner to diversify their portfolio.

When there’s diversity in the portfolio, there’s the potential for future liquidity. In UPREIT exchanges, property owners can defer capital gains on any appreciated property until they sell the OP units.

UPREIT Examples

To help you have a better understanding of how UPREITs work, let’s look at Vanguard, Fidelity, and Lamar UPREITs. All three investment agencies allow property owners to share their contributed property to avoid capital gains.

Each one lets you have limited partnership units so that you can avoid high taxes on your property while earning passive income.

These larger or umbrella partners will take on your property when you pay it off and are ready to sell so that you can earn income without having to pay high taxes.

UPREIT Advantages

There are several advantages to UPREITs for property owners. Below, you’ll find the main benefits of investing in UPREITS:

Tax advantages:  The income tax benefits of UPREITs are that you can defer capital gains on real estate, which is ideal for properties with a low tax basis.

Long-term passive income: For those looking to have passive income coming in over a long period of time, UPREITs are ideal. When you have OP units, you automatically receive passive income from the REIT.

Use of the Section 721 exchange: Unlike other investments, UPREITS allow you access to the 721 exchange.

Future liquidity: When owners convert OP units to REIT shares, they can sometimes control the timeline for future liquidity. However, having control can trigger capital gains.

Profile diversity: As an investor, having a diverse portfolio is ideal. As a REIT shareholder, you can have a larger portfolio, which includes a mix of tenants, geographies, ages, etc.

It simplifies property owners’ estate: If the property owner passes, the estate is easier to divide because OP units can be divided evenly.

Single properties are often more complicated to divide than UPREIT properties in the event of the owner’s death.

UPREITs Disadvantages

We can only talk about UPREITs and their advantages if we also discuss their potential disadvantages. Knowing the disadvantages is essential when deciding whether to invest in an UPREIT.

These are the disadvantages of UPREITs:

Taxes are complicated to file: Since dividends go to all shareholders, the more you have, the more taxes you’ll have to file. You’ll want to hire a tax advisor knowledgeable about UPREITs to assist you so that you file everything correctly.

There’s a one-time tax deferral: You can defer capital gain taxes with UPREITs, but it’s only a one-time deferral. You can avoid this taxable gain under UPREITs.

Finding a buyer can take time: Finding a buyer doesn’t always take a long time, but it can, which can be a considerable disadvantage to UPREITs.

There’s a lack of control: Once investors have a stake in the property, the owners lose much of their previous control regarding property management.

UPREIT Requirements

If you’re thinking about joining an UPREIT, there are several requirements that you’ll need to meet in order to do it correctly.

The process requires several accounting and tax codes. Since UPREITs allow the contributing property into the REIT for ownership shares, IRC Section 721 tax laws guide the UPREIT structure.

IRC Section 721 standards outline everything you need to know about tax shields regarding property and share exchanges. Any exchanges within a REIT can be called an UPREIT.

Most REITs will focus on a particular area of the real estate stock market. Guiding standards state that real estate property and all financing must be more than 90% of all business.

UPREITs follow a similar investing strategy but focus on specific real estate niches.

IRC Section 1031 allows a property owner to sell their real estate and invest in the property in what’s known as a like-kind exchange.

A like-kind sale helps them avoid taxes, much like Section 721. Section 721 is far more attractive for UPREITs.

UPREIT vs. DownREIT: What’s The Difference?

At their core, UPREITs and DownREITs are still REITs, but there is a difference between the two that you need to be aware of.

A DownREIT is a joint partnership between the REIT and someone who owns the property; an UPREIT doesn’t require real estate ownership outright.

So, if you want to diversify your investment portfolio without purchasing real estate property, you can still technically have real estate shares in an UPREIT.

DownREIT exchanges are based on the value of the real estate property that the REIT and owner have. When exchanges are based on the market value, it usually allows for better returns than an UPREIT.

Who Should Use an UPREIT?

UPREITs are great investment options for those who are looking to diversify their investment portfolio. The more diverse your portfolio is, the lower the risk of losses you’ll experience.

Losses happen when investing, but limiting your risk of losses with UPREITs is ideal. Those who could benefit the most from an UPREIT are property owners with only one commercial property or a handful (not dozens) of properties.

These individuals can benefit from an UPREIT the most, so they can reap the benefits of a more extensive REIT portfolio. Other people who could benefit from an UPREIT would be partnerships or families who want to sell jointly owned properties.

They may want to do this to address succession issues or if they don’t want to deal with property management. Business owners who wish to lease their properties and mitigate risk might take advantage of UPREITs too.

If you feel like an UPREIT might be a good option for you and your investment portfolio, start looking into REITs today and see which would be the best option.

There are several options to consider, such as Fidelity, Lamar, and Vanguard. Getting started isn’t too challenging, and you can start earning passive income in no time.

UPREIT FAQ’s

UPREITs can be confusing, but they don’t have to be. We’ve found three of the most frequently asked questions about these investments.