As property values continue to climb and owners are considering selling their medical real estate the main question we hear is, “where will I put my money to replace the income?”. At times it seems that using the 1031 method to defer capital gains tax is a foregone conclusion. Our healthcare real estate team’s response to a seller will typically be, “would you like tax-deferred treatment on the money you are going to re-invest? If so, which tax-deferred transaction type do you want?” Then we can answer the question.
Recently, a resurgence of a tax-deferred transaction allowing 100% reinvestment of the funds has been extremely attractive for owners. Physician groups executing a disposition through a sale-leaseback have especially found this appealing. This transaction is known as an Umbrella Partnership Real Estate Investment Trust or UPREIT.
Go to HBRE.US for a more detailed description of the mechanics of an UPREIT. In this reading I hope to give you a basic understanding of the pros and cons of each transaction type.
1031 or Like-Kind Exchange
From the closing of the previously held property the seller has 45 days to identify up to 3 new properties and 180 days to close to avoid capital gains tax. The tax is deferred until cash is recognized through a sale of the property without executing a 1031 exchange.
Pros
- Control: Maintain control of real estate
- Simple: Typically, as easy as identify in 45 days and close in 180 days
- Real Estate to Real Estate: “Dirt” or property will almost always exist even when stock goes away and ordinarily the value recovers
Cons
- Unpredictable: Time constraints can lead to bad real estate decisions or tax event
- Liquidity: Real estate is historically less liquid than other investments
- Diversification: Time restrictions make it difficult to re-invest in multiple properties
Umbrella Partnership Real Estate Investment Trust (UPREIT)
Seller contributes property to an operating partnership (UPREIT) which is a quasi-subsidiary of the REIT. In return, the REIT gives operating units to the seller which remain invested in the operating partnership for the tax deferral. At any time, the seller can convert those operating units into REIT shares or the REIT can sell the property outside of an agreed upon “lockout period”. Both events will trigger an end to the tax-deferral. Again, go to HBMRE.com for a more detailed description.
Pros
- Predictable: Re-investment of funds is pre-determined
- Liquidity: UPREIT operating units are convertible to REIT stock anytime
- Diversification: UPREIT typically holds multiple properties
Cons
- Limited control: After “lockout period” REIT can sell property and trigger tax event
- Complicated: Structure of UPREIT transaction has many moving parts
- Real Estate to Stock: If stock goes away asset is gone
Reach out to us at hbre.us or 615-564-4133 for further discussion on which transaction is right for you. Of course, always seek legal counsel from an attorney and/or CPA on these matters.
