FAQ Real Estate Investment Trust Morrison Foerster | 6 ▪ Estate Planning – OP Units are helpful for estate planning purposes. For example, an OP Unitholder can transfer OP Units to multiple beneficiaries as part of estate planning, and each beneficiary can choose either to hold his or her OP Units and receive quarterly distributions or tender the OP Units for redemption for cash or, at the REIT’s election, for REIT shares. In addition, when an individual partner holds the OP Units until death, the tax rules generally allow for a “step up” in tax basis of the OP Units, effectively permitting the beneficiaries to subsequently tender the OP Units for cash or REIT shares without incurring tax on the built-in gain in the OP Units at the time of death. For more information regarding public UPREITs and OP Unit transactions, including securities law, tax law and other considerations, see our publication entitled “Frequently Asked Questions about UPREITs and OP Unit Transactions forPublic REITs.” Are there any drawbacks to the UPREIT structure or engaging in an OP Unit transaction? Yes, despite the benefits described above, UPREIT structures can have some drawbacks that should be considered by sponsors and property sellers. UPREIT structures introduce a level of complexity that would not otherwise exist within a REIT structure that does not include an Operating Partnership subsidiary. Additionally, the disposition of property by an UPREIT may result in a conflict of interest with the contributing partner because any disposition of that property could result in gain recognition for that partner. As a result, contributing partners often negotiate mandatory holding periods and other provisions to protect the tax deferral benefits they expect to receive through contribution of appreciated property to an UPREIT. What is a DownREIT? DownREITs are similar to UPREITs in that both structures enable holders of real property to contribute that property to a partnership controlled by the REIT on a tax-deferred basis. The primary difference between the two structures is that DownREITs typically hold their assets directly and/ or through multiple operating partnerships or other subsidiaries (each of which may hold only one property or a small subset of properties), whereas UPREITs typically hold all of their assets through a single operating partnership subsidiary. The DownREIT structure enables existing REITs to compete with UPREITs by allowing them to offer potential sellers a way to dispose of real estate properties on a tax-deferred basis. As with an UPREIT structure, in a DownREIT, limited partnership interests in an operating company are redeemable for cash based upon the fair market value of the REIT shares or, at the REIT’s election, for REIT shares. As distinguished from an UPREIT, however, for a DownREIT, the value of each DownREIT partnership unit is not necessarily directly related to the value of the REIT shares, because, unlike UPREITs, where the value of REIT shares is determined by reference to all of the REIT’s assets, for a DownREIT, the value of each DownREIT unit is determined by reference to the specific assets held in only one of the DownREIT’s partnerships. As a result, there is not necessarily a correlation between the value of each DownREIT partnership’s assets and the value of the REIT shares. However, as a practical matter, almost all DownREIT agreements tie the redemption to a 1:1 ratio. Such a structure raises additional issues regarding the tax-free nature of a contribution by a property seller to a DownREIT partnership.
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