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.
