UPREIT vs. DownREIT

By Thomas P. Roussel | December 25, 2023

Woman researching UPREITs and DownREITs

Real estate investment trusts (REITs) are companies that purchase and manage real estate properties. They operate, finance, or own commercial properties, generating income and dispersing it to shareholders as dividends. REITs can allow investors to diversify their portfolios and earn income from multiple properties without the task of managing or purchasing the property themselves.

Several types of REITs are available for investment opportunities, including UPREITs and DownREITs. These investments have slight differences that can make them more or less suited for some investors. Many investors prefer UPREITS over DownREITs because they are less complicated and offer greater tax benefits. However, a DownREIT can be the ideal choice for some investors based on their financial standing, tax preferences, and ability to manage or own property. Learning about UPREIT and DownREIT variations helps investors make the most effective investment.

What Are UPREITs?

An umbrella partnership real estate investment trust (UPREIT) is an arrangement between property owners and a REIT. Owners exchange their real estate for units in an operating partnership (OP). These units usually have an agreed-upon value between the REIT and the property owner. After a certain period, investors can convert the OP units into cash, REIT shares, or other forms of compensation. These exchanges are also called 721 exchanges.

UPREITs can be advantageous for investors because they allow for deferment of capital gains taxes. Other arrangements require immediate capital gains payments, which can reduce the sale profits. For instance, selling your property for cash results in immediate tax liabilities. In contrast, you are only liable for taxes when redeeming your OP units for REIT shares.

Many investors redeem UPREIT shares over time, which allows them to pay the tax liability over time rather than all at once. Investors often seek out UPREITs to achieve goals like:

  • Improving tax management: Property owners might want to sell real estate without triggering a significant capital gain. A 721 exchange lets them defer taxes until they redeem shares later. Additionally, the UPREIT owner’s heir receives a step-up in basis to the UPREIT’s value at the time of the owner’s death.
  • Accessing passive income: Investors could seek passive income from real estate without management responsibilities. UPREITs allow for the potential of consistent income without management duties.
  • Increasing diversity in their portfolio: UPREITs help you expand your portfolio with new property types and redemption opportunities.

What Are DownREITs?

DownREITs are alternatives to UPREITs. They consist of a joint partnership between property owners and REITs. In this arrangement, partners own and operate real estate properties. Like UPREITs, investors can defer capital gains taxes on the contributed properties. However, DownREITs establish a limited partnership agreement instead of an umbrella partnership.

Instead of exchanging properties for units in a partnership, DownREITs let you contribute property to the joint venture. Then, the partnership leases the real estate to the REIT, which pays rent to the limited partnership. You can structure the joint partnership in various ways that match your financial goals and needs. DownREIT structures can become complicated, so it’s always best to consult a professional tax advisor before establishing the partnership. Choosing the wrong structure for you might cause you to lose the ability to defer capital gains taxes.

Investors often choose DownREITs as an alternative option to UPREITs because they prefer a joint partnership over an umbrella partnership arrangement. They receive a portion of rental income in addition to partnership units, which can offer consistent payment. Financial professionals can help you determine a DownREIT’s impact on your portfolio and the most effective partnership structure.

UPREITS vs. DownREIT

What Are the Differences Between UPREITs and DownREITs?

UPREITs and DownREITs have a few significant differences that make them more or less suitable for investors. Understanding these variations helps you make the most informed decision for your circumstances.

These are the essential differences between UPREIT vs. DownREIT:

  • Tax benefits: Both exchange types allow for deferment of capital gains taxes. However, UPREITs have a simpler tax structure that can make these tax advantages more attainable. DownREITs have a more complicated structure that must follow all standards from the Internal Revenue Service (IRS). If you do not meet these guidelines, the IRS might deem the exchange a taxable event. Investors can work with financial experts to ensure the DownREIT abides by the required structure or choose an UPREIT to simplify the process.
  • Potential returns: Investors often choose DownREITs when they anticipate a property can appreciate more than a REIT portfolio. The DownREIT operates as a joint partnership, which holds assets at a partner level. Because the investor contributes property, they can gain more interest returns over time.
  • Partnership status: UPREITs allow investors to gain units in an operating partnership, while DownREITs build a joint partnership between the REIT and real estate owner. Investors might prefer the unit arrangement or want a more established partnership for their exchange. 
  • Voting: An UPREIT offers limited voting rights in comparison to a DownREIT.

How to Choose Between UPREITs and DownREITs

Both UPREITs and DownREITs can help you diversify your portfolio and access tax benefits. However, one type might fit your financial goals more than the other. Consider these factors when choosing between DownREITs vs. UPREITs:

  • Financial standing: If you anticipate your property could appreciate more than the REIT portfolio, a DownREIT allows your assets to be held at a partnership level. You retain more interest in a DownREIT structure than an UPREIT. In addition, the DownREIT investment performance depends on the investor’s property, not the overall REIT performance.
  • Tax preferences: DownREITs have a more complex structure and often need more tax preparation to qualify for capital gains tax deferment. Investors might opt for UPREITs for the simpler tax requirements, which could help them achieve tax deferment more easily. Depending on your experience with taxes, you might feel more comfortable with one option or the other. Working with tax professionals is recommended to ensure you meet all IRS requirements for either choice.
  • Ability to own or manage property: DownREITs have real estate ownership rights that might result in additional management responsibilities, depending on the structure you arrange with the REIT. UPREITs do not have any property management responsibilities.

Register

Register With 1031 Crowdfunding Today

Both UPREITs and DownREITs expand your investment portfolio and provide opportunities to defer capital gains taxes. By understanding their differences, you can choose the exchange option that meets your needs more closely.

1031 Crowdfunding has assisted with more than $2.4 billion in real estate transactions. Our expert management team has extensive experience with many investment structures, including UPREITs and DownREITs. We offer DSTs with 721 UPREIT options.

To get started with 1031 Crowdfunding, register for an investment account with us today.

This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees and other expenses. This literature must be accompanied by, and read in conjunction with, a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results, and forward-looking statements and projections are not guaranteed to achieve the results described and your actual returns may vary significantly. Investments in private placements are illiquid in nature and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice and you should consult with your tax advisor as individual tax situations will vary. Securities offered through Capulent, LLC Member FINRA, SIPC.

Coffee mug, eyeglasses, and laptop sitting on table

GET OUR FREE EBOOK!

Sign up for our newsletter and receive a free copy of our ebook.

Includes tips on how to:

  • Increase Cash Flow Potential
  • Lower Your Closing Risk
  • Diversify Your R/E Portfolio
This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.