Investors Explore UPREITs as Alternative to 1031s
June 14, 2021
President Biden’s tax proposal that puts 1031 exchanges on the chopping block is shining a spotlight on UPREITs as an alternative strategy to defer capital gains taxes.
The UPREIT structure leverages Section 721 of the Internal Revenue Code, which allows investors to contribute ownership of a property to a partnership subsidiary of a REIT in exchange for a partnership interest or operating partnership (OP) units. Effectively, the OP units are used as currency. The property seller can defer capital gains taxes or depreciation recapture taxes until the time that they convert those units into shares of stock. The conversion of the partnership units into shares of stock is the taxable transaction.
“I would expect there to be a bigger increase in UPREITs if 1031s were to be repealed,” says Rony Rodriguez, a partner at CohnReznick and a member of the firm’s commercial real estate and financial services Industry practices. If the current proposal to limit the amount of capital gains that could be deferred in a 1031 exchange to $500,000 is approved, it would effectively eliminate the use of 1031 exchanges for many sellers.
