UPREIT

The UPREIT structure was developed in the early 1990s as a way to bridge the gap between private real estate ownership and publicly traded REITs. At any point during the trading day, property owners who wanted to participate in a REIT had to sell their properties first, triggering immediate recognition of capital gains. The UPREIT solved this by inserting an operating partnership between the REIT's shareholders and its underlying properties.

When a property owner contributes real estate to a UPREIT, the owner receives OP units in the operating partnership rather than cash or REIT shares. Because this contribution is structured as a tax-deferred exchange under IRS rules, the capital gain embedded in the property is not recognized at the time of contribution. The owner continues to receive distributions from the partnership, which function similarly to REIT dividends.

OP unit holders generally have the right to convert their units into REIT shares or cash after a holding period, typically one year. The conversion itself is a taxable event, but the UPREIT structure allows owners to control the timing of that tax liability rather than being forced into an immediate realization.

For the REIT, the UPREIT structure makes it easier to grow the portfolio by acquiring properties from owners who would not otherwise sell due to embedded capital gains. The ability to use OP units as acquisition currency gives large UPREITs a competitive advantage in assembling diversified property portfolios.

Most major publicly traded REITs in the United States are organized as UPREITs. Investors who hold shares in a REIT are indirectly investing in the operating partnership, which owns and operates the underlying properties. The REIT itself serves as the general partner or managing member of the operating partnership and holds the majority of OP units.