An UPREIT, short for umbrella partnership real estate investment trust, is a structure that lets a property owner contribute real estate to a REIT’s operating partnership in exchange for operating partnership units, or OP units, instead of cash. Because the IRS treats this contribution under Section 721 of the tax code rather than as a sale, the owner generally defers capital gains tax and depreciation recapture at the time of the transaction rather than paying it immediately.
Most large, publicly traded U.S. REITs are organized this way. The structure exists because a direct sale of appreciated property to a REIT is a taxable event for the seller, and that tax bill often discourages owners from selling at all. The UPREIT format gives REITs a way to acquire property from owners who would otherwise hold on to it indefinitely, and it gives those owners a path into a diversified, professionally managed real estate portfolio without an immediate tax hit.
This article walks through how the structure works, what OP units actually are, the tax mechanics behind them, and where the real risks sit for anyone considering one.
What is an UPREIT?
An UPREIT is a REIT that holds substantially all of its properties through a subsidiary limited partnership called the operating partnership, rather than owning real estate directly. The REIT itself typically serves as the general partner of the operating partnership and owns most of the partnership interests, called OP units, through the capital it has raised by selling REIT shares to public investors.
When a property owner contributes real estate to the operating partnership, they receive OP units instead of REIT shares or cash. Those units are economically similar to REIT shares. They’re generally entitled to distributions comparable to the dividends paid on REIT stock, and they can usually be converted into REIT shares or cash later on, at the REIT’s election, once a holding period has passed.
The structure traces back to 1992, when Taubman Centers used it to complete what REIT executives at the time reportedly called one of the more difficult IPOs in the sector’s history, largely because investors and the market had never seen the two-tier structure before. According to Nareit, the industry’s trade association, that transaction and its supporting tax opinion opened the door for private property owners to contribute real estate to REIT-controlled partnerships without triggering immediate tax liability, and the format quickly became standard across the industry.
How does an UPREIT work?
The mechanics follow a fairly consistent pattern, though specific terms vary by REIT and by the contribution agreement negotiated for each deal.
A property owner who holds a highly appreciated asset, say an office building bought decades ago for a fraction of its current value, faces a large capital gains and depreciation recapture bill if they sell it outright. Instead of selling, the owner contributes the property to the REIT’s operating partnership. In return, they receive OP units valued at the property’s fair market value, minus any debt the partnership assumes.
Because the transaction is structured as a contribution to a partnership under Section 721, rather than a sale, no gain is recognized at that point. The owner’s tax basis in the property carries over to the OP units, so the built-in gain isn’t eliminated, only deferred. That gain stays deferred as long as the owner holds the OP units and the operating partnership doesn’t sell the underlying property.
Most operating partnership agreements include a lock-up period, commonly around 12 months, before a unit holder can request redemption. After that period, the holder can typically ask the operating partnership to redeem the units for cash equal to the value of an equivalent number of REIT shares, or the REIT can elect to deliver shares instead. Converting to REIT shares or accepting cash is a taxable event: the deferred gain is recognized at that point, even though no property has been sold in the traditional sense.
UPREIT structure explained
The relationship between the parties involved looks like this:
Public shareholders
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REIT (general partner, holds most OP units)
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Operating Partnership (owns the real estate)
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Contributing property owners (hold OP units)
The REIT sits at the top and is the entity whose shares trade publicly (for publicly listed UPREITs) or are offered to investors (for non-traded REITs). The operating partnership sits below it and holds the actual real estate. The REIT typically contributes the cash it raises from investors into the operating partnership in exchange for OP units, giving it a controlling interest and the general partner role. Property owners who contribute real estate directly to the partnership also receive OP units and become limited partners alongside the REIT.
Because OP unit holders are limited partners rather than shareholders, they generally have no vote at the REIT level, and any conflicts between what’s best for the REIT’s public shareholders and what’s best for OP unit holders are usually resolved according to terms spelled out in the partnership agreement. That’s worth understanding before contributing property, since it shapes how much say a former owner has once their asset is inside the structure.
What are OP units?
OP units are limited partnership interests in the REIT’s operating partnership. They aren’t shares of REIT stock, and there’s no public market for them the way there is for listed REIT shares.
The key differences from REIT shares:
- Liquidity: OP units generally can’t be sold on an exchange. A holder typically has to wait out a lock-up period, then request redemption for cash or exchange for REIT shares before achieving the kind of liquidity that publicly traded stock offers.
- Taxation: OP unit holders are treated as partners for tax purposes, meaning they receive a Schedule K-1 and are taxed on their share of the partnership’s taxable income, which can differ from how REIT dividends are taxed to shareholders.
- Conversion: Most partnership agreements allow OP units to convert to REIT shares, often on a one-for-one basis, but the timing, valuation method, and whether the REIT can pay cash instead of stock all depend on the specific partnership agreement. Terms are not standardized across UPREITs.
Property owners typically receive OP units rather than REIT shares directly because contributing property in exchange for OP units qualifies for tax deferral under Section 721, while receiving REIT shares directly in exchange for property would generally be treated as a taxable sale.
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Why do REITs use UPREIT structures?
REITs adopted the umbrella partnership format primarily to make property acquisitions easier, not as a tax-avoidance scheme for the REIT itself. The tax deferral benefit flows to the contributing property owner, and that benefit is what makes owners willing to sell to a REIT they might otherwise ignore.
A few practical reasons the structure persists:
Owners of long-held, highly appreciated property are often reluctant to sell for cash because of the resulting tax bill. Offering OP units as consideration removes that obstacle and opens up acquisition targets that a cash buyer couldn’t access on the same terms.
The operating partnership can also raise capital independently, through debt or equity issued at the partnership level, giving the overall structure more financing flexibility than a REIT that owns property directly.
REITs must also continually satisfy IRS qualification tests to keep their tax status: at least 90% of taxable income must be distributed to shareholders each year, at least 75% of gross income must come from real estate sources, at least 95% must come from real estate plus other passive sources like interest and dividends, and at least 75% of assets must consist of real estate, cash, or government securities, tested quarterly under Internal Revenue Code Sections 856 through 859. The UPREIT format doesn’t change these requirements, but it gives REITs a flexible way to grow their asset base while staying within them.
Advantages of an UPREIT
For the property owner contributing real estate, the main draws are tax deferral and diversification. Instead of concentrating all their wealth in one building, they hold an interest tied to a much larger, professionally managed portfolio spread across property types and markets. Distributions on OP units are typically structured to track REIT dividends, so income doesn’t necessarily stop just because the owner no longer manages the property directly.
There’s also an estate-planning angle worth understanding. Under Internal Revenue Code Section 1014, assets included in someone’s estate generally receive a step-up in basis to fair market value at death. If an OP unit holder holds their units until death rather than converting or redeeming them, their heirs typically inherit the units at the stepped-up basis, which can eliminate the originally deferred capital gains tax entirely rather than simply postponing it further. OP units can also be divided among multiple heirs more easily than a single piece of real estate.
For the REIT, the benefit is access to acquisition targets and capital sources that a purely cash-based buyer wouldn’t have, along with the operational simplicity of no longer having to manage a property directly once it’s absorbed into a professionally run portfolio.
None of this guarantees a better financial outcome. The value of OP units still depends on the performance of the REIT’s underlying properties and management decisions the original owner no longer controls.
Disadvantages and risks of an UPREIT
The structure adds real complexity and trade-offs on both sides.
Liquidity is limited during the lock-up period, and even after it ends, OP units aren’t publicly traded the way REIT shares are. A holder who needs cash quickly may not have the option to sell on their own timeline.
Converting OP units to REIT shares or accepting a cash redemption triggers the deferred gain in full, so the tax deferral has an expiration point tied to the holder’s own decisions, not an open-ended shelter. If mortgage debt on the contributed property exceeds the owner’s tax basis in it, the excess debt relief can be treated as a deemed cash distribution under Internal Revenue Code Section 752(b), which can trigger a partial taxable gain right at contribution, before any units are ever converted. This is a detail that’s easy to miss and worth reviewing with a tax advisor before agreeing to terms.
Because any future sale of the contributed property by the operating partnership would recognize the deferred gain for the original contributor specifically, contributors and REITs sometimes have conflicting interests over when to sell that property. Contributors often negotiate mandatory holding periods on the specific asset they contributed to protect their deferral, according to legal guidance published by Morrison & Foerster on UPREIT transactions.
OP unit holders are also limited partners with no vote at the REIT board level, market risk tied to the REIT’s overall performance rather than just their original property, and dependence on the specific terms of a partnership agreement that can vary significantly between REITs. It’s worth reading that agreement closely, or having a tax and legal professional review it, before contributing.
UPREIT vs traditional REIT
| Feature | UPREIT | Traditional REIT |
|---|---|---|
| Basic structure | REIT holds real estate indirectly through an operating partnership | REIT holds real estate directly, or through wholly owned subsidiaries |
| Operating partnership | Central to the structure; REIT is typically the general partner | Not used, or used minimally |
| Property contributions | Owners can contribute property for OP units on a tax-deferred basis | Property is typically purchased for cash or REIT stock, which is generally taxable to the seller |
| OP units | Issued to contributing property owners; convertible to REIT shares or cash after a lock-up period | Not applicable |
| Tax considerations | Contribution can defer capital gains under Section 721; conversion later triggers the deferred gain | Direct sale to the REIT is a taxable event for the seller at the time of sale |
| Complexity | Higher, due to the two-tier partnership structure and partnership agreement terms | Lower, since there’s no separate operating partnership layer |
| Typical use | Common among larger REITs seeking to acquire property from owners reluctant to sell for cash | Common among REITs built primarily through direct purchases or ground-up development |
Nearly all large, publicly traded equity REITs in the U.S. use some version of the UPREIT format today, so in practice, “traditional REIT” more often describes smaller or newly formed REITs that haven’t adopted the two-tier structure, rather than a competing mainstream approach.
UPREIT vs DOWNREIT
A DOWNREIT works on a similar principle, tax-deferred contribution of property in exchange for partnership units, but the legal structure differs. Instead of contributing property to one central operating partnership that holds the REIT’s entire portfolio, a DOWNREIT investor forms a separate joint venture partnership with the REIT for that specific property or a small group of properties.
That distinction matters for how the units are valued. In an UPREIT, OP unit value tracks the value of the REIT’s entire portfolio, since all properties sit inside the same operating partnership. In a DOWNREIT, the joint venture unit’s value is tied more directly to the performance of that specific contributed property, which can appeal to an owner who believes their asset will outperform the REIT’s broader portfolio, but it also means DOWNREIT structures are typically more complex to administer and have drawn closer IRS scrutiny than the more standardized UPREIT format.
A hypothetical UPREIT example
Consider a hypothetical scenario for illustration only. A property owner holds a commercial retail building purchased many years ago for $2 million, now worth $8 million, with a remaining tax basis of $1 million after depreciation. Selling the property outright for cash would trigger tax on roughly $7 million of gain, including both capital gains and depreciation recapture.
Instead, the owner contributes the building to a REIT’s operating partnership in exchange for OP units valued at $8 million. No gain is recognized at contribution because the transaction qualifies under Section 721, and the owner’s original $1 million basis carries over to the OP units. The owner now holds a diversified interest in the REIT’s broader portfolio rather than a single building, and receives distributions on the OP units similar to what REIT shareholders receive as dividends.
After the partnership agreement’s lock-up period passes, suppose two years, the owner could request redemption of the units for cash or exchange them for REIT shares. At that point, the deferred $7 million gain would generally be recognized. Alternatively, if the owner holds the units until death, their heirs would typically receive a step-up in basis to the units’ fair market value at that time, which could eliminate the originally deferred gain for federal income tax purposes. This example is illustrative only and doesn’t reflect actual tax outcomes for any specific transaction, which depend on the individual’s basis, debt levels, state tax rules, and the specific partnership agreement involved.
Are UPREITs good for investors?
An UPREIT is a legal and tax structure, not an investment strategy in itself, and it doesn’t guarantee better returns than owning property directly or investing in a REIT through the public markets. Whether it’s a good fit depends heavily on individual circumstances.
For someone who already owns appreciated real estate and wants to reduce single-property concentration risk without an immediate tax bill, the structure can offer genuine diversification benefits, trading exposure to one building for exposure to a portfolio spread across markets and tenants. For someone simply looking to invest new capital in real estate, buying REIT shares directly on the public markets is a far simpler path. UPREIT contributions are specifically for owners who already hold appreciated property they want to exit without a taxable sale.
Liquidity is the trade-off most investors underestimate going in. OP units are illiquid relative to REIT shares until the lock-up period ends and redemption or conversion occurs, and that conversion resets the tax clock on the deferred gain. Anyone evaluating this path should weigh the diversification and estate-planning benefits against the loss of control over the specific property and the eventual tax bill that conversion or a sale by the operating partnership will trigger.
UPREIT tax considerations
The core tax mechanic is straightforward in concept and more nuanced in practice. Contributing property to an operating partnership in exchange for OP units under Section 721 generally isn’t a taxable event, so the capital gains and depreciation recapture that would otherwise apply to a cash sale are deferred rather than eliminated. The owner’s basis in the contributed property carries over to the OP units received.
A few specifics that matter:
The deferral ends when the OP units are converted to REIT shares, redeemed for cash, or when the operating partnership sells the contributed property outright, any of which generally triggers recognition of the previously deferred gain.
If the property carried debt at the time of contribution and that debt exceeds the owner’s basis, the excess can be treated as a deemed cash distribution under partnership tax rules, potentially causing partial gain recognition immediately, even before any units are converted.
Holding OP units until death can result in a step-up in basis for heirs under Section 1014, which may eliminate the deferred gain rather than just postponing it, though large estates may still be subject to separate estate tax depending on the size of the estate and applicable exemption thresholds at the time.
None of this is personalized tax advice, and the details depend heavily on individual basis, debt levels, state tax treatment, and the specific partnership agreement. Anyone considering an UPREIT contribution should work through the numbers with a qualified tax professional and a real estate attorney before signing a contribution agreement.
Frequently asked questions about UPREITs
What does UPREIT stand for?
UPREIT stands for umbrella partnership real estate investment trust, a structure where a REIT holds its properties through a subsidiary operating partnership rather than directly.
What is an UPREIT in simple terms?
It’s a way for a property owner to trade real estate for units in a REIT’s operating partnership instead of selling for cash, which generally defers the capital gains tax that a direct sale would trigger.
How does an UPREIT work?
A property owner contributes real estate to the REIT’s operating partnership and receives OP units in return. The transaction is structured under Section 721 of the tax code, so no gain is recognized at contribution. The owner’s original tax basis carries over to the units.
What are OP units in an UPREIT?
OP units are limited partnership interests in the operating partnership. They generally track the value of REIT shares and can typically be converted to REIT shares or redeemed for cash after a lock-up period, but they aren’t publicly traded themselves.
Are UPREITs tax-free?
No. The tax is deferred, not eliminated, unless the units are held until death and receive a step-up in basis for heirs. Converting units or a sale of the underlying property by the operating partnership generally triggers the deferred gain.
What is the difference between an UPREIT and a REIT?
An UPREIT is a specific type of REIT that holds its properties through an operating partnership rather than directly. Nearly all large, publicly traded REITs today use this structure.
What is the difference between an UPREIT and a DOWNREIT?
An UPREIT uses one central operating partnership for the REIT’s entire portfolio. A DOWNREIT uses a separate joint venture for a specific property or small group of properties, so unit value ties more closely to that individual asset’s performance.
What are the risks of an UPREIT?
Limited liquidity until the lock-up period ends, eventual recognition of the deferred gain upon conversion or sale, potential immediate gain recognition if contributed debt exceeds basis, no voting rights at the REIT level, and dependence on the specific terms of the partnership agreement.
Can OP units be converted into REIT shares?
Usually, yes, often on a one-for-one basis after a lock-up period, though the REIT typically has the option to pay cash instead, and exact terms vary by partnership agreement.
Are UPREITs suitable for individual investors?
They’re primarily relevant to individuals who already own appreciated real estate and want to defer tax on a sale while diversifying into a REIT portfolio. They aren’t a typical entry point for someone simply looking to add REIT exposure to a portfolio; buying REIT shares directly serves that purpose more directly.