Key Benefits of Using the 721 UPREIT Exchange
The 721 UPREIT Exchange offers significant advantages for real estate investors, including tax deferral, portfolio diversification, consistent income generation, and smart estate planning.
Tax Deferral
The 721 UPREIT Exchange allows investors to defer capital gains taxes, providing a tax-efficient way to manage real estate investments. This can be particularly beneficial in the context of President Joe Biden’s proposed tax changes, which may limit the benefits of 1031 like-kind exchanges and increase long-term capital gains tax rates.
Portfolio Diversification and Consistent Income
By exchanging real property for operating partnership units (OP Units) in a REIT, investors can diversify their holdings across various geographic locations, tenant industries, and asset classes. This reduces dependency on a single asset and provides a steady income flow through regular distributions from the REIT, similar to the cash flow generated by the previously owned property.
Estate Planning Benefits
The 721 UPREIT Exchange also offers significant estate planning benefits. Investors can use this structure to pass assets to their heirs, who receive a step-up in basis upon the investor’s death. This allows heirs to avoid capital gains taxes and depreciation recapture. OP Units can be converted into REIT shares for easier disposition compared to selling real property.
Impact of Biden’s Tax Proposals
While President Joe Biden’s tax proposals aim to increase taxes for high-net-worth taxpayers, the Green Book from the Treasury Department details significant impacts on high-income real estate investors. The proposed limitations on 1031 like-kind exchanges and increased tax rates on long-term capital gains are notable.
The proposal would allow the deferral of gain up to $500,000 for each taxpayer ($1 million for married individuals filing a joint return) annually for like-kind exchanges of real property. Gains exceeding these limits would be recognized in the year of the transfer. This proposal would be effective for exchanges completed in tax years beginning after December 31, 2021.
Advantages of 721 Exchange (UPREIT) Transactions
Given the potential limitations of 1031 exchanges, the 721 Exchange (UPREIT) transaction presents an attractive alternative. Through an UPREIT structure, real estate owners, operators, and investors can exchange their real property for OP Units in a REIT without paying taxes at the time of the transaction. The exchange is considered tax-free under Section 721 of the Internal Revenue Code, and the tax on the potential gain continues to be deferred as long as the OP Units are held.
However, investors contributing property with a built-in gain or loss must have the built-in gain or loss allocated to them when recognized by the partnership, typically when the partnership disposes of the contributed property in a taxable transaction. Future depreciation and amortization deductions arising from contributed property with a built-in gain or loss must be allocated among partners, indirectly having the contributing partner pick up some of that built-in gain or loss over time, as per Section 704(c) of the Code.
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