Features Management

Real Estate Family Business Succession and UPREIT Strategy

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For families that hold real estate, planning for succession is a difficult but important challenge. Real estate succession planning for families can be a great opportunity to maximize returns and in such a way that the tax liability may be minimized. Yet, often, the next generation of the family is not qualified or even interested in continuing to manage the family real estate business. There could be numerous stakeholders with conflicting interests or who hold grudges against certain relatives.

In addition to the possible absence of a qualified family member to take over the management of the family real estate business, other issues may exist which complicate succession plans. Properties may be held in partnerships that may need to be dissolved. Such partnerships may hold long-term assets with very low basis but high current market values. Property owners may be concerned that they have too much of their net worth tied up in real estate, especially as they get older. Properties may have leases with third parties that may be soon up for renewal. Family owners may no longer be willing to invest the time and effort that such negotiations would entail.

Family owners who decide to move on need to evaluate their options carefully. Such options need to reduce the accumulated investment and liquidity risk of the real estate holdings and reduce the management burden while retaining wealth in the family and minimizing the income tax burden upon an exit. A creative solution to provide more flexibility and help achieve these outcomes is an umbrella partnership real estate investment trust (UPREIT).


An UPREIT is a strategic partnership structure that allows a real estate investor to defer capital gains, often with improved diversification, liquidity and more strategic tax management. Through an UPREIT, a real estate owner contributes their ownership of the property to an operating partnership owned by a real estate investment trust (REIT). The REIT is typically a publicly traded entity that raises cash by selling stock. The REIT will then contribute the cash raised through the sale of stock to the operating partnership in exchange for operating partnership units. The REIT usually acts as the general partner of the operating partnership.

A REIT is a corporation that receives special tax treatment and combines the capital of many investors to acquire and/or provide financing for all forms of real estate. A REIT is, in many ways, like a mutual fund for real estate, with investors obtaining the benefit of a diversified portfolio under professional management. REITs do not pay tax at the corporate level, meaning there is no double taxation of the income to shareholders. In exchange for this special tax treatment, the REIT must comply with several requirements, one of which is that the REIT must distribute at least 90% of its annual taxable income to shareholders.

The original real estate owner receives limited partnership units of the operating partnership (OP units) in return for contributing their property. The contribution of property by a partner to a partnership is not generally a taxable event, but it is subject to certain rules at the time of contribution. Commonly, the UPREIT structure will include other limited partners from other real estate investments who have also contributed their properties into the operating partnership. This may provide additional diversification, as the partnership becomes a fund of various real estate properties, potentially mitigating risk.

The UPREIT structure provides an attractive tax-deferred exit strategy for owners of real estate who would otherwise recognize a significant taxable gain in the cash sale of a highly appreciated property with a low tax basis. If the real estate were transferred directly for shares of a REIT, the owner would have to immediately recognize the built-in gain in the year of the transfer. However, the real estate owner can avoid current gain recognition by contributing the property to the UPREIT in exchange for operating partnership units. The real estate owner would have a basis in the operating partnership units equal to the basis of the real estate contributed.

Tax Advantages

A contribution of property to a partnership is generally tax-free, and a distribution of cash from a partnership to a partner is generally tax-free to the extent of the partner’s basis in its partnership interest. However, certain tax regulations do provide that a partner’s contribution of property to a partnership and a related distribution of money or other consideration from the partnership to the partner will generally be treated as a sale (a “disguised sale”) if, when viewed together, the transactions are properly characterized as a sale or exchange.

Transfers between a partner and a partnership within two years of each other are presumed to be a disguised sale. The tax regulations do provide certain exceptions under which it may be possible for contributing partners to receive cash distributions from the operating partnership without jeopardizing the tax-tree status of the contribution. Amounts that the contributor receives for capital expenditures incurred with respect to the contributed property during the two-year period preceding the contribution are excluded.

If a partner contributes property to a partnership and the partnership assumes or takes the property subject to a liability of the partner that is not a “qualified liability,” the transaction would be treated as a disguised sale. A qualified liability includes: (1) a liability incurred by the contributing partner more than two years before the transfer and which has encumbered the transferred property throughout the two-year period, (2) a liability incurred by the contributing partner within the two-year period that was not incurred in anticipation of the transfer of the property and has encumbered the transferred property since it was incurred and (3) the liability is allocable, under the tracing rules of the tax regulations, to capital expenditures with respect to the property.

The capital gains taxes which would have been due upon the sale of the appreciated property remain deferred as long as the operating partnership holds it and the original owner holds the OP units. Capital gains taxes become due if the unit holder exchanges the OP units for REIT shares, the OP unit holder exchanges the OP units for cash or the contributed property is sold by the operating partnership.

Operating partnership units may be converted over time so as to spread out and lessen any tax impact. OP unit holders have the right to convert their OP units into REIT shares on a one-for-one basis. Conversion from OP units to REIT shares is considered a taxable event, so the investor may choose to convert over time, enabling the investor to incur any tax liability in smaller increments. Often, the REIT shares are soon sold after conversion to pay for any tax liability due. If OP units are owned at the time of death of an OP unit holder, there would be a step-up in basis eliminating any taxable gain which existed prior to death.

The OP units are equal in value to the REIT shares and fluctuate in value in the same way. OP unit holders also receive distributions equal to the dividends paid on REIT shares. However, OP units and REIT shares are taxed differently. An OP unit owner is deemed to earn a portion of the total income of the operating partnership, including income from each of the states in which it transacts business. REIT shares generate income that is taxable on the dividend distributions to shareholders. Shareholders would generally only have to file a tax return and pay tax in their state of residency.

The tax deferral under the UPREIT structure is often compared to the deferral under a 1031 exchange. The UPREIT structure does not require the sale of property and the need to identify a replacement property within 45 days of the sale of the relinquished property. Once identified, the owner must then acquire the replacement property within 180 days of the sale of the relinquished property. The original owner would still have the property management responsibilities with no change in liquidity and diversification that is accompanied under the UPREIT structure.

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