By: Orrin Barrow, Vice President at Kay Properties and Investments, LLC
Here at Kay Properties, we have many clients who inquire about different 1031 exchange options. Some of our investors have inquired about the 721 UPREIT (Umbrella Partnership Real Estate Investment Trust) mechanism in both DSTs and Private and Publicly Registered Non-Traded REITS. The question that many investors ask is – Can I 1031 Exchange into a REIT? The 721 UPREIT can be a potential answer to this question, however there are multiple items that investors must be aware of and carefully consider prior to deciding to pursue this route.
- After The 721 UPREIT transaction is completed, it marks the end of an investor’s 1031 exchange capabilities. If an investor utilizes the 721 UPREIT then they will no longer be able to utilize the 1031 exchange, and when they sell their interests in the REIT that they exchanged into via the 721, they will be paying their taxes. For many investors, the idea of no longer being able to defer their federal capital gains taxes, state capital gains taxes, depreciation recapture tax and medicare surtax is a frightening thought – some of these investors then decide that a 721 UPREIT is not for them. An approach that we have utilized is one in which an investor exchanges a portion of their equity via the 721 UPREIT and with the rest of their equity they then continue to utilize the 1031 exchange into Delaware Statutory Trusts (DSTs) whereby they are able to defer future taxes.
- Investors need to be aware that with a 721 UPREIT, their interest in real estate will be transferred to Operating Partnership (OP) units. Many investors are not aware that the OP units are, or will be, if the REIT lists on a stock exchange, potentially tied to a fluctuating stock price. Due to the volatility of the stock market, investors who utilize a 721 UPREIT into a REIT that is public or will potentially go public in the future, are subject to the ups and downs of the stock market and are no longer owners of private real estate.
- The 721 UPREIT often has liquidity and pricing lock-ups that many investors are not always aware of. Utilizing the 721 UPREIT, an investor could be trapped in a Private or Publicly Registered Non -Traded REIT for 5-15 years or even forever causing the investment to actually be highly illiquid as opposed to the liquidity they hoped they were going to receive by selling there shares once the REIT was publicly traded. Again, this is why we use the approach of using a portion of the 1031 exchange proceeds in a 721 UPREIT strategy, and then deploy the remainder into a portfolio of DST properties that will have the potential for a staggered exits whereby the investor has the choice of 1) doing another 1031 exchange into more DSTs (where the investor must read the Private Placement Memorandum of each DST to understand the business plan and risk factors of investing in DSTs), 2) doing another 1031 exchange into any other type of like-kind property that they would own and manage on their own or 3) cashing out and paying their taxes.
- Private to Public conversion of REITs have, in certain circumstances, been favorable for investors, and in many other cases have been terrible for investors. We have seen many Private to Public REIT conversions result in large losses to investors. Last year we saw a situation where a Publicly Registered Non Traded REITs properties were solid but upon going public the investors lost millions of dollars overnight. Again, this example is an example of one REIT going public and may not be the outcome of all REITs becoming publicly traded. We all understand that with real estate investing there are no guarantees, however investors need to understand that the 721 UPREIT is no exception. This is the reason why not putting all of your 1031 equity into one offering that is planning on a 721 UPREIT is prudent. Even if the offering has a large portfolio of properties, it is still a standalone investment that investors should protect themselves from concentration risk via diversifying into multiple separate DST offerings.
The 721 UPREIT can be a useful tool for investors when utilized within a broader diversification strategy. We at Kay Properties are big proponents of encouraging our clients to use various strategies to build a diversified portfolio for their 1031 exchanges. For a free consultation on the various 1031 exchange, Delaware Statutory Trust, and 721 UPREIT offerings we have available, please register at www.kpi1031.com.
* Diversification does not guarantee profits or protect against losses.