A 1031 exchange allows investors to sell a real estate property and exchange it for another property if the conditions are met. A 1031 exchange permits the owner to defer capital gains. For the last sixteen-plus years, investors have had the option of selling their property and going into a passive ownership role with a DST.
What if you want to set things up for beneficiaries who all want to go in different directions with the asset when they receive it? Enter the 721 exchange or UPREIT strategy. An UPREIT is a unique Real Estate Investment Trust (REIT) that allows the exchange of a sale of real estate for shares of ownership of the UPREIT.
Pros of Using an UPREIT as Part of Your Financial Strategy
1. Tax Deferral: Just like a 1031/DST, the capital gain on the sale is deferred when exchanged into an UPREIT program. So, for most people, keeping 20 percent of your money instead of Uncle Sam taking it is preferred.
2. Diversification: Most 1031/DST are individual properties. With a 721/UPREIT, you receive shares of an already-built portfolio of many properties, tenants, etc. Some UPREITs specialize in focused asset classes (essential retail, multi-family, industrial, etc.), while other UPREITs are more diversified and balanced in real estate asset classes. As the investor, you get to pick the type of UPREIT that fits your goals.
3. Liquidity: The shares of the UPREIT are typically more liquid than a DST or individual property. This allows each beneficiary to decide whether to stay invested in the REIT or cash out.
4. Passive income: REIT investors, including UPREIT, are passive shareholders and have none of the headaches of owning the property directly. You also receive quarterly or monthly income based on the properties’ rents in the portfolio.
5. Capital Appreciation Potential: Owning cash-flowing, rented real property over time typically grows in value. While this is never guaranteed (neither is the rental income), the old saying “God is not making any more land” applies here. Compared to some listed stocks, UPREITs tend to have a smoother ride for the investor.
6. Estate Planning: This is where a 721/UPREIT shines the most. REIT shares are easily divided between beneficiaries (way more than trying to do that with an individual property).
Cons of Using an UPREIT As Part of Your Financial Strategy
First, a 721/UPREIT exchange is a tool and is not appropriate for everyone. The younger the investor, the less it makes sense. Once you exchange into the 721/UPREIT, you are off the 1031 merry-go-round and can’t get back on.
Capital loss: All investments, including real estate, can and do decrease in value in specific economic cycles. Just ask anyone who owns an office building. UPREITs are not immune, so you need to understand the properties of the UPREIT portfolio. The rent rolls, tenants, length of rental agreements, and location all matter. Most UPREITs have some level of legacy assets. Those are properties put into the portfolio years ago, and depending on the purchase price and asset class, those properties may not be worth that today.
Loss of control: As a shareholder in an UPREIT, you have no absolute control. Sure, you can vote, but that’s about it. You need to be okay with the loss of control and loss of flexibility. The 721 is the last “stop” for the money that was initially in the individual property. Unlike a DST, you can’t 721 again into another program.
The UPREIT strategy can be a beneficial one for investors of real estate. It allows them to defer capital gains, similar to a 1031, but also allows individual beneficiaries to invest in different investments. For older real estate investors who no longer want to be landlords, don’t want to pay capital gains on a sale, and would like their estate to be easier to handle, a 721/UPREIT should be considered.
Read more at Forbes.
Securities are offered through Arkadios Capital. Member FINRA/SIPC. Advisory services are offered through Creative Capital Wealth Management Group. Creative Capital Wealth Management Group and Arkadios are not affiliated through any ownership.
This material was created for educational and informational purposes only and is not intended as tax, legal, or investment advice.
Frederick Hubler is the Founder and CEO of Creative Capital Wealth Management Group, a retainer-based wealth strategy firm specializing in alternative strategies located in Chester County.