UPREITs as a 1031 Exchange Replacement Property Strategy
What Is a REIT?
A Real Estate Investment Trust (REIT) works much like a mutual fund, but instead of stocks and bonds, it invests in real estate. Investors pool their money to buy shares, and the REIT then acquires and manages income-producing properties.
REITs can be:
Publicly traded, like stocks, where shares are bought and sold on an exchange.
Non-traded (private), where shares are sold through licensed brokers and dealers.
The main benefits of REITs are diversification and cash flow — many distribute attractive dividends thanks to rental income from the properties they own.
Can You 1031 Exchange Into a REIT?
Here’s where investors often get confused. While REITs own real estate, buying shares in a REIT is not considered owning real estate — it’s considered buying a security.
That means a traditional 1031 Exchange (which requires replacing one real property with another “like-kind” real property) cannot be used to directly swap into a REIT.
But there is a workaround: the UPREIT, which allows investors to access REITs while still deferring taxes.
What Is an UPREIT (1031/721 Exchange)?
An Umbrella Partnership Real Estate Investment Trust (UPREIT) is a structure that combines the tax advantages of a 1031 Exchange with the diversification and passive ownership benefits of a REIT.
It works in two steps:
1031 Exchange – The investor sells their relinquished property and exchanges into a fractional (Tenant-in-Common) interest in a property already owned or designated by the REIT.
721 Exchange – After a holding period (often 12–24 months), the investor contributes that TIC interest into the REIT’s operating partnership. In return, the investor receives operating partnership (OP) units, which function like shares in the REIT.
At this point, the investor has effectively transitioned from owning direct real estate to owning a stake in the REIT — all on a tax-deferred basis.
Benefits of the UPREIT Strategy
For many investors, UPREITs offer a compelling exit strategy. Here’s why:
Tax Deferral – Both capital gains and depreciation recapture are deferred as long as the REIT holds the property and the investor holds their OP units.
Diversification – Instead of owning one building, investors participate in a portfolio of professionally managed real estate.
Passive Income – REITs distribute regular dividends, often providing consistent cash flow.
Estate Planning – OP units can be inherited with a step-up in basis, potentially eliminating deferred taxes for heirs.
Relief from Management – Investors no longer deal with tenants, maintenance, or property oversight.
Risks and Limitations to Consider
As attractive as UPREITs sound, they come with trade-offs that investors must understand:
No Way Back to 1031 – Once you convert into OP units, you no longer own real estate. That means you cannot 1031 Exchange back into property later. Any sale of OP units is a taxable event.
Loss of Control – The REIT (not you) decides if and when to sell the underlying property. If the REIT sells, it could trigger the recognition of deferred gains and depreciation recapture.
Sponsor Guarantees Vary – Some UPREIT sponsors offer guarantees against triggering taxes for a certain period; others provide no such assurances. Due diligence is essential.
Who Should Consider an UPREIT?
UPREITs may be appealing to:
Investors nearing retirement who want passive income and diversification without property management headaches.
Families using real estate wealth for estate planning, since OP units can simplify inheritance.
Investors who already plan to exit real estate permanently and want access to institutional-quality assets without reinvesting in another single property.
On the other hand, investors who want to maintain flexibility for future 1031 Exchanges or who prefer direct ownership control may find UPREITs too restrictive.
UPREITs as a Bridge Between Real Estate and Securities
UPREITs occupy a unique middle ground. They let real estate investors leverage the tax deferral power of a 1031 Exchange, while transitioning into a more liquid, diversified, and professionally managed structure.
The key is understanding the trade-offs: you gain simplicity and diversification but give up control and the ability to exchange back into property later. For the right investor profile, an UPREIT can be a smart way to unlock long-term income and estate planning benefits while avoiding an immediate tax bill.
