Real Estate Investment Trusts (REITs) have transformed real estate investing by offering liquidity, diversification and tax efficiency. Among the most advanced structures are UpREITs (Umbrella Partnership REITs) and DownREITs, which allow property owners to contribute appreciated assets without triggering immediate tax liabilities. While both share common goals, their mechanics and benefits differ significantly, making it essential for investors to understand when and why to use each.
What Is an UpREIT and How Does It Work?
An UpREIT structure enables property owners to exchange real estate for operating partnership (OP) units in a REIT’s umbrella partnership, which holds pooled assets. These OP units can later be converted into REIT shares or cash, providing liquidity while deferring capital gains taxes under IRC Section 721.
Benefits of UpREITs
There are several benefits of UpREITs, including:
- Tax Deferral on Appreciated Assets: Owners avoid immediate capital gains taxes when contributing property, preserving wealth and improving after-tax returns.
- Estate Planning Advantages: Through the estate, OP units can be passed to heirs, who may convert them into REIT shares without triggering capital gains, which simplifies estate liquidity needs.
- Liquidity and Diversification: Conversion into REIT shares offers exposure to a diversified portfolio of properties, reducing concentration risk.
- Access to Institutional-grade Assets: Property owners gain entry into professionally managed portfolios, often including high-quality commercial assets.
- Centralized Management: Control remains with REIT management, allowing owners an opportunity to step back from the day-to-day management.
What Is a DownREIT and Why Choose It?
A DownREIT involves forming a joint venture between the property owner and the REIT, where the contributed property remains in a separate partnership entity. The owner receives units tied to the performance of their specific property rather than the entire REIT portfolio.
Benefits of DownREITs
Like UpREITS, there are also numerous benefits to DownREITs. These include:
- Property-specific Performance: Owners retain upside potential if their property outperforms the REIT’s broader portfolio.
- Tax Deferral Opportunities: Similar to UpREITs, DownREITs allow deferral of capital gains taxes, though the structure is more complex and requires careful compliance.
- Customizable Partnership Terms: DownREITs offer flexibility in structuring economic arrangements, appealing to owners with unique property characteristics.
- Greater Control: Owners may retain more decision-making power and control over their specific assets
Real-world Examples of UpREIT and DownREIT Strategies
The following real-world scenarios illustrate how UpREIT and DownREIT strategies can be applied to address different investment objectives and circumstances.
Example 1: UpREIT Strategy for Estate Planning
A family-owned shopping center with a low tax basis was contributed to a large retail REIT via an UpREIT structure. The owners received OP units, deferred millions in capital gains taxes, and later converted units into REIT shares for liquidity. This move simplified estate planning and provided heirs with diversified exposure to retail assets.
Example 2: DownREIT for Property-specific Upside
A hotel owner partnered with a hospitality REIT through a DownREIT structure. The property was in a booming tourist market expected to outperform the REIT’s overall portfolio. By retaining performance-linked units, the owner captured significant upside while still deferring taxes.
UpREIT vs. DownREIT: Comparative Analysis
To further help clarify the distinctions between UpREIT and DownREIT structures, consider the following comparison table, outlining their key features:
|
Feature |
UpREIT |
DownREIT |
|
Tax Deferral |
Yes | Yes |
|
Liquidity |
High (convertible to REIT shares) | Lower (units tied to property) |
|
Diversification |
Broad REIT portfolio | Concentrated in specific property |
|
Complexity |
Lower | Higher |
|
Estate Planning |
Strong benefits | Moderate benefits |
Strategic Considerations for UpREIT vs DownREIT Decisions
When deciding between an UpREIT or a DownREIT, consider the following factors to guide your decision-making process:
- Evaluate Market Performance Trends: Analyze whether the REIT’s overall portfolio is expected to outperform individual assets. UpREITs are ideal for broad exposure and risk mitigation, while DownREITs work best when a specific property is positioned for high growth.
- Assess Liquidity Requirements: UpREITs provide easier conversion to REIT shares, making them suitable for investors seeking near-term liquidity. DownREITs are better for those comfortable with illiquidity and focused on long-term appreciation.
- Understand Tax and Compliance Complexity: Both structures offer tax deferral benefits, but DownREITs involve more complex partnership agreements and heightened IRS scrutiny. Professional tax guidance is essential for compliance.
- Plan for Estate and Succession Goals: UpREITs simplify estate transfers and provide heirs with diversified, liquid assets. DownREITs may complicate planning due to property-specific performance and valuation challenges.
- Align With Risk Tolerance and Investment Strategy: UpREITs reduce concentration risk through diversification across multiple assets. DownREITs concentrate risk but offer potential for outsized gains if the property significantly outperforms.
Recent Legislative Changes Impacting REIT Strategy
Public Law (P.L.) 119-21, commonly known as the "One Big Beautiful Bill Act" (OBBBA) introduced several key changes that enhance REIT planning flexibility and investor certainty, including:
Permanent Section 199A Deduction for REIT Dividends
The 20% Qualified Business Income (QBI) deduction for ordinary REIT dividends is now permanent, locking in a favorable effective tax rate for shareholders.
Increase in Taxable REIT Subsidiary (TRS) Asset Limit
Starting in 2026, REITs can hold up to 25% of total assets in TRS securities (up from 20%), providing greater flexibility for structuring operating businesses.
Business Interest Deduction Relief
Section 163(j) interest deduction limitation will revert to the more favorable EBITDA-based calculation, allowing REITs and leveraged investors to deduct more interest expense.
Removal of Proposed Foreign Investor Penalties
The final law removed the “retaliatory tax” provision, preserving current tax treatment for foreign investment in U.S. REITs.
Why These Structures Matter
For investors and property owners, these structures are not just tax tools — they are strategic levers for wealth preservation, portfolio optimization and estate planning. In a market where flexibility and efficiency are paramount, understanding UpREITs and DownREITs can unlock significant long-term value.
Ready to explore which structure fits your goals? Contact your Cherry Bekaert Real Estate industry professional today for personalized guidance and strategic planning.
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