What is a REIT?

“REIT” stands for “Real Estate Investment Trust.” REITs are investment vehicles that allow investors to pool capital to invest in real estate assets. Unlike regular corporations, REITs typically don’t need to pay federal corporate income tax on income that they distribute, eliminating “double taxation” (getting taxed at both the corporate AND stockholder levels). A type of REIT called an “UPREIT” may be able to acquire properties on a tax-deferred basis. 

What is an UPREIT?

“UPREIT” stands for “Umbrella Partnership REIT.” With this type of REIT, all of the REIT’s properties are actually owned by an operating partnership. The REIT itself is a holding company that owns “Operating Partnership (OP) units,” which are units of limited partnership interest of the operating partnership that owns the properties. The REIT is also the sole general partner of the operating partnership that owns the properties. Instead of selling for cash, if a property owner contributes their property to the operating partnership in exchange for OP units, the property owner may be able to defer the recognition of taxable income on any gains that would normally be incurred with the property sale. 

How do OP unit transactions work?

After negotiation with the operating partnership, a property owner contributes their property to the operating partnership for a number of OP units. In general, OP units receive cash distributions per unit equal to the cash distributions per share made on the REIT’s common stock. 

All dividends declared on the REIT’s common stock, if any, are at the sole discretion of the Board of Directors. 

Pursuant to the terms of the operating partnership’s partnership agreement, the OP unitholder, at any time after an initial holding period, can choose to exchange their units for shares of the REIT’s common stock or, at the REIT’s option, cash. The exchange for shares (or cash) is a taxable transaction. 

What are the benefits of an OP unit transaction?

Deferred Gain 

Property owners may be able to defer their capital gain until (i) the REIT sells the property, (ii) the OP units are exchanged for common stock (or cash), or (iii) in certain cases, the operating partnership reduces the debt on the property. 

Estate Planning 

Subject to the terms of the operating partnership’s partnership agreement and federal securities laws, OP units can be conveyed to heirs before or after death. When OP units are transferred through inheritance, under current law, the heir’s tax basis will be “stepped up” to fair market value at the time of the contributor’s death, potentially reducing future capital gains tax. Heirs can choose to exchange OP units for common stock (or cash, at the REIT’s option) on their own timetables. 

Relief from Property Management Responsibilities 

By contributing properties in exchange for OP units, property owners can continue to receive regular cash distributions per unit equal to the per share cash distributions made on the REIT’s common stock, without having the responsibilities of property management. 


Property owners who contribute their property in exchange for OP units will have partial ownership in a larger, geographically diverse portfolio, which could reduce the risks associated with owning a single property or a smaller group of properties. 

Income from Distributions 

U.S. federal income tax law requires that a REIT distribute at least 90% of its net taxable income every year. Holders of OP units receive cash distributions per unit equal to the dividends per share on the REIT’s common stock. If a REIT increases its per share dividendthen the per unit distribution to the OP units would also increase. 

Potential for Share Price Appreciation 

As the REIT grows its portfolio and cash flow, the market value of a share of REIT stock may increase. Of course, market value could also decrease, depending on the REIT’s operations and market conditions. After an initial holding period, an OP unitholder can exchange their OP units for REIT common stock (or, at the REIT’s option, cash), generally on a one-for-one basis. An exchange could allow the OP unitholder to take advantage of any increases in market value in REIT common stock. 

How long is the capital gains tax deferred?

Depending on the particular circumstances of the property contributor, the capital gain may be deferred as long as the operating partnership holds the property and the OP unitholder holds the OP units. Capital gains taxes become due when: (a) the OP unitholder chooses to exchange the OP units for common stock (or cash, at the REIT’s option); (b) the contributed property is sold by the operating partnership; or (c) in some cases, the operating partnership reduces the debt on the property. 

If the OP units are still owned at the time of the OP unitholder’s death under current law, there would be a step-up in basis, eliminating any taxable gain in the OP units which may have existed prior to death. 

Also, it’s important to note that OP units can be converted over time, at the OP unitholder’s election, to spread out and lessen the tax impact in smaller increments. 

How do cash distributions work for OP units?

OP unitholders receive cash distributions per unit equal to the cash dividends paid per share on common stock. 

Are OP units the same as common stock?

Economically‚ OP units are generally the same as shares of common stock in the REIT. OP units generally can be exchanged on a one-for-one basis with REIT common stock, so REIT shares essentially determine the value of OP units. OP unitholders receive per unit distributions equal to the per share dividends paid on common stock. 

Unlike shareholders, OP unitholders don’t have voting rights as shareholders because OP unitholders are not owners of the REIT. 

OP units are taxed differently than common stock shares for income tax purposes (for instance, OP unitholders earn a portion of the total income from each state in which the operating partnership owns properties, whereas REIT shareholder income is only taxed in the shareholder’s state of residency, in addition to other differences). 

How are OP units valued?

OP units can be exchanged on a one-for-one basis with shares of REIT common stock, so the market price of REIT shares essentially determine the value of OP units. The current price of common stock for a publicly traded REIT at any time is determined by the market.  

Can OP units be used as collateral for a loan?

In certain cases‚ OP units may be pledged as collateral to a lender‚ achieving additional liquidity while maintaining tax deferral benefits. 

Who could consider an OP unit transaction?

An OP unit transaction could be considered if a property owner is looking to: (a) defer capital gains upon the sale of a property; (b) free the owner from property management responsibilities; (c) diversify their ownership interest across a larger portfolio of properties; or (d) facilitate estate planning. In addition‚ an OP unit transaction may make sense for the following categories of property owners: 

  • Families in need of succession planning 
  • Partnerships that may need to be dissolved 
  • Long-term owners with a low tax basis in their properties
  • Owners interested in diversifying their holdings, either across additional properties or outside of real estate altogether 

The above addresses several commonly asked questions about REITs and operating partnerships. The questions above do not describe any particular definitive documents, do not cover all situations, and do not apply to all taxpayers based on their circumstances. You must consult your own advisor regarding the consequences to you of any transaction based on your particular circumstances.