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Real Estate Investment Trust (REIT) Taxation

New Yorkers and other Americans are sconsistently drawn to real estate as a potential source of income. This remains true despite the real estate calamities of the late 2000s.  This fixation with real estate is almost quintessentially American.  Here in the U.S., we have a history of striving for real estate ownership.  Many view it as a marker of status, security and stability. In plenty of other places around the world, notably in Europe, much less attention is focused on owning real estate. No matter how harshly the market behaves, it appears that there is never a shortage of real estate investors.  Many open their wallets and gamble that a given property will yield good returns on a consistent basis.   One real estate investment vehicle which seems to be rising in popularity is the Real Estate Investment Trust, or REIT.

Absent a dramatic shift in cultural attitude, there’s little reason to expect that this state of affairs will change. 

Similar to a Delaware Statutory Trust (or DST), a REIT involves investor co-ownership of real estate. DSTs generally involve a single large property co-owned by multiple investors.  REITs, however, involve multiple properties co-owned by multiple investors. In this article, we will discuss REITs in detail.  We’ll then describe the process of contributing investment real estate to a REIT, following a 1031 exchange.  

It’s definitely worthwhile for you to be aware of how REITs operate.  That’s because these entities can provide a potentially highly valuable means to generate steady returns in commercial real estate. 

The REIT is a Pool of High-Performing Properties 

An ownership interest in a REIT is dissimilar in kind from an interest in a DST or tenants-in-common entity. This is because interests in REITs are considered personal property.  The others are interests in real property. When someone owns equity in a REIT, they possess shares of stock in the entity.  That’s the same as if they were shareholders in a traditional corporation. REITs can be either privately owned or publicly traded entities.  

Entities must meet certain requirements in order to qualify as a REIT. For instance, the entity must have at least 100 shareholders.  Also, no more than 50% of the total shares may be held by five individuals or fewer. The entity also has to be taxable as a corporation.  It must be managed by a board of directors or trustees. If an entity doesn’t meet these, and other, requirements, it cannot be classified as a REIT for tax purposes. 

Multiple Pieces of Property

REITs hold multiple pieces of income-generating real estate in a portfolio. This portfolio is managed according to whatever strategy or strategies a given REIT chooses to employ. In general, REITs specialize in different sectors.  Accordingly, one REIT may have a portfolio consisting of commercial properties exclusively from a certain industry.  Another REIT may concentrate its focus in yet a different area.  

Holding interests in a REIT carries many benefits. For one, investors can have access to properties which would otherwise be inaccessible. Lots of investors are unable to acquire a large commercial property entirely on their own.  REITs provide a convenient means to acquire a slice of this type of property. Often these entities have professional managers or teams of managers.  Accordingly, investors can look forward to a steady, consistent stream of passive income. 

1031 Exchange Context: UPREITs 

At the entity level, REITs are able to conduct exchanges in the same manner as any other corporate entity. Just as with a typical partnership, the REIT can sell one or more of its investment commercial properties.  It can then acquire like-kind replacement property on the purchase side. However, REITs also provide individual investors contemplating a tax-deferred exchange under Section 1031 with a unique opportunity.  REITs can maximize the profitability of their transaction. Individual investors may partake in an UPREIT, or “Umbrella Partnership REIT”.  This allows them to receive interests in the REIT when they contribute a commercial property to the REIT’s portfolio.

Here’s how the UPREIT process works.  An investor conducts a 1031 exchange in a standard fashion. Then, if the property is something of interest to the REIT, the investor can contribute that property directly to the REIT.  In return, the investor receives “operating units” in the REIT. These operating units represent equity in the entity.  They’re also usually convertible into REIT common stock. 

Choose Experience

If you’re planning to conduct a 1031 exchange to eventually be part of an UPREIT, it’s best to consult with an experienced tax attorney.  They can usually help you navigate through this process. The details of the process are a bit convoluted when viewed in their entirety.  There’s lots to know about the convertibility of operating units, repurchase options, selling operating units on the open market, etc.

Call New York City Tax Attorneys For Help

In general, investing in a REIT can be a great way to take part in a well-diversified pool of commercial real estate.  A REIT allows investors to invest in assets that are otherwise much less accessible. The attorneys here at Mackay, Caswell & Callahan, P.C. have advised clients on a wide range of 1031 issues.  We’re more than happy to assist you as well.  If you have an issue in this or another area, please don’t hesitate to reach out.  One of our top New York City tax attorneys is ready to help. 

Image credit: Janis O’Carroll