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UPREIT Considerations

In a previous article Real Estate Investment Trusts (REIT) and Umbrella Partnership Real Estate Investment Trusts (UPREIT) were discussed in the “realm” of a 1031 like kind exchange.  As a follow up to such article, the article below will discuss some potential benefits regarding an UPREIT as well as potential disadvantages or items for consideration and potential concern.  As always, if you are considering a potential transaction such as a 1031 like kind exchange, UPREIT or other you should consult your tax attorney, business attorney or other attorney regarding the matter.  The article below is for informational purposes only.

If the investor invests in the UPREIT, the investor may enjoy a deferral of capital gain and depreciation recapture as long as the UPREIT continues to hold the investment property, and of course the investor must continue to hold their interest in the operating partnership.  Thus, given the right circumstances, an UPREIT can provide a potential exit strategy for investors that wish to defer taxes and get “out” of a situation whereby they own real property and may feel like a real estate manager, or rather are tired of being the property manager.   Therefore, an investor may be able to diversify their real estate tax portfolio while also deferring taxes, which makes the UPREIT a potentially tempting investment for many property owners who enjoy holding real estate as investment, but wish to no longer only own a few pieces of real estate and/or be responsible for their upkeep, the leasing etc.

Of course there are risks associated with an UPREIT and some of the potential risks that should be considered are stated and discussed below.  You must keep in mind that if you exchange into an UPREIT you no longer own the real estate, you would now own a security.  Further, you cannot use a 1031 like kind exchange to get out of the UPREIT and invest into other real property, and the sale or other disposition of your interest in the UPREIT is likely to result in a taxable transaction, whereby you would then recognize the deferred capital gain and any necessary depreciation recapture.

In terms of control, you must understand and accept that the UPREIT will control the asset they 1031 exchange and therefore will control the sale or disposition of the asset.  As stated above the sale or disposition of the asset may lead to the recognition of capital gain and depreciation recapture by the investor.  You may find an UPREIT whereby those in control, or the sponsor agrees or guarantees to not trigger a taxable event (gain) for specific period of time, while others will not promise anything.

If you have questions regarding these transactions, speak with a your advisors, such as a tax attorney, business attorney or other tax professional.  You can receive a free consultation with a Denver tax attorney by contacting The McGuire Law Firm.

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What is an UPREIT?

The article below has been drafted by a tax attorney at The McGuire Law Firm to provide information regarding Real Estate Investment Trusts and 1031 Exchanges.  Please note the article below is for informational purposes and you should always consult a tax attorney, business attorney or another attorney experienced with your issues before entering into any transaction of which you are not sure of the business and/or tax consequences.

What is a Real Estate Investment Trust?  A Real Estate Investment Trust, commonly referred to as a REIT could be compared to a mutual fund, but with real estate investments.  Investors purchase an interest in a REIT and the REIT buys real estate.  The above explanation may be overly simplified as there are a number of requirements for a REIT, but for the purposes of this article such explanation will suffice.  The REIT will generally acquire numerous real estate investments and thus the advantage to an investor in a REIT is that they should have a  more diversified real estate portfolio than if they purchased one residential property or commercial property alone or with a small number of investors.

Often real estate investors will inquire as to their ability to use a 1031 Exchange with a real estate investment for an interest in a Real Estate Investment Trust (REIT).  This would not be allowed, or would not allow for a tax deferral because the interest in a REIT would be akin to a security interest, not an interest in real estate for purposes of a like kind exchange under Internal Revenue Code Section 1031.  This real estate investor would need to acquire a direct interest in real estate to qualify for a IRC Section 1031 like kind exchange.

In regards to the above issue, an Umbrella Partnership Real Estate Investment Trust (UPREIT) may be an option based upon an investor’s situation, circumstances and goals.  A UPREIT, which may also be referred to as a 1031 and 721 exchange can potentially provide the same tax deferral benefits to an investor that a 1031 Like Kind Exchange would provide.  An UPREIT may be structured as a two step process: first, a tax deferred exchange under 1031 followed by a tax deferred contribution of real property to a partnership.

During the first step, instead of finding a suitable replacement property for the relinquished property, the investor will identify a fractional interest in real estate that the/a REIT has already designated.  In the second step, the fractional interest is contributed to a partnership, controlled by IRC Section 721whereby no gain is recognized upon the contribution of property to a partnership.  However, it is important to note that other code sections such as IRC 731 and 752 could come into play depending upon the overall circumstances.

The above is a simplified statement of an Umbrella Partnership Real Estate Investment Trust, but hopefully provides an example of the idea and transaction.  Any questions or concerns should be discussed with your attorney, a tax attorney, real estate attorney, business attorney and/or your CPA.

If you have questions regarding the tax implications of certain transactions, please feel free to contact The McGuire Law Firm to speak with a tax attorney through a free consultation.

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