DownREIT

DownREIT is a joint endeavor between a real estate owner and a real estate investment trust (REIT) for the purpose of acquiring and controlling real estate.

DownREIT involves a partnership arrangement between a real estate owner and the (REIT) that assists the real estate owner in deferring capital gains tax on the sale of appreciated real estate.

Real estate owners who contribute property to DownREITs receive operating units in a partnership. This partnership entity and the property owner’s relationship to it can be structured in a variety of different ways, depending on the structure of the REIT and any UPREITs that may exist.

Unlike UPREITs, which do not own real estate and act basically as an umbrella for a number of business entities that own real estate, a DownREIT does own real estate. Some of this property is owned outright, while some may be owned through limited partnerships with those who have contributed property to it.

The DownREIT is less widely used than the UPREIT because it is more complicated and may not have the same tax advantages as an UPREIT. Contributing property to a DownREIT is a complex transaction requiring professional tax and investment guidance. If the transaction is not structured with extreme care, the IRS may consider the transfer of property into the DownREIT in exchange for operating units to be a taxable transaction under disguised-sale or anti-abuse rules. Hence, an UPREIT may be the more logical choice for a property owner whose primary concern is to defer income tax liability.

However, a DownREIT can be a logical option if the property owner thinks his real estate will appreciate more than the REIT’s other holdings, because he retains a greater interest in his contributed property with a DownREIT than he would with an UPREIT.

That said, since the ownership structure of a DownREIT is more complex, converting operating units to cash requires more complex calculations. Likewise, UPREITs and DownREITs perform differently as investments since they are structured differently. With a DownREIT, the partnership between the REIT and the investor can perform differently than the performance of the REIT as a whole. DownREITs are similar to UPREITs, however, in their value as an estate planning tool. Both step up the basis of the operating units upon the owner’s death, allowing a tax-free transfer of appreciated real estate to heirs. Heirs can then convert the operating units into REIT shares or cash without paying tax.