Real Estate Investment Trusts (REITs) and Master Limited Partnerships (MLPs) are both popular structures for real estate and infrastructure investments. They offer distinct tax advantages and capital formation strategies, particularly when forming joint ventures. This article explores how joint venture tax structuring differs between REITs and MLPs, their respective benefits and limitations, and how investors and sponsors can align their goals using either model.
Overview of REITs and MLPs
REITs are corporations or trusts that own or finance income-producing real estate across a range of property sectors. To qualify as a REIT under U.S. tax law, at least 75% of a REIT’s assets must be invested in real estate, and at least 90% of its taxable income must be distributed as dividends to shareholders annually. In exchange, REITs are not taxed at the corporate level, avoiding double taxation.
MLPs are publicly traded partnerships that combine the tax benefits of a partnership with the liquidity of public markets. MLPs are most commonly found in energy infrastructure but have been used in other capital-intensive sectors, including real estate. Unlike REITs, MLPs do not have a mandatory distribution requirement, but they offer pass-through taxation, meaning income is only taxed at the individual partner level.
Tax Structuring in Joint Ventures
Joint ventures (JVs) allow entities to pool capital, share risks, and combine expertise. Tax structuring of these ventures is crucial in determining after-tax returns and ensuring compliance with federal and state tax regulations. Here’s how REITs and MLPs approach JV structuring differently.
REIT Joint Ventures
Use of UpREITs and DownREITs
REITs often structure JVs using an UpREIT or DownREIT format:
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In an UpREIT, the REIT operates through an umbrella partnership REIT structure. Property owners contribute assets to an operating partnership (OP) in exchange for OP units, which can be converted to REIT shares.
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In a DownREIT, the REIT partners directly with the property owner in a lower-tier partnership.
Tax Deferral
These structures allow property owners to defer capital gains taxes through §721 exchanges, where appreciated property is exchanged for partnership interests. This can be especially attractive in a JV context, as the REIT can acquire property without triggering immediate tax consequences for the contributor.
Compliance Requirements
To maintain REIT status, strict requirements must be met:
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Asset and income tests: At least 75% of income must come from real estate-related sources.
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Distribution requirement: 90% of taxable income must be distributed annually.
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Ownership limits: No more than 50% of shares can be owned by five or fewer individuals.
Joint ventures must be carefully structured to ensure these thresholds are not violated. Non-qualifying income from the JV could jeopardize the REIT’s status.
Related-Party Rules
Special attention must be paid to transactions between the REIT and related parties in a JV, particularly regarding pricing and management fees, to avoid excise taxes or disqualification.
MLP Joint Ventures
Flexibility in Asset and Income Types
MLPs are more flexible in the types of income and assets they can own, provided they generate “qualifying income” under §7704(d). While real estate may not traditionally fall within MLP qualifying income rules, real estate infrastructure—like pipelines or storage facilities—may qualify if structured correctly.
Pass-Through Taxation
MLPs are not subject to entity-level tax. Income, losses, deductions, and credits flow through to limited partners (LPs), who report them on individual tax returns via Schedule K-1. This can make MLP JVs more tax-efficient for certain investors.
Basis and Depreciation
Investors in MLPs benefit from basis adjustments and pass-through depreciation, which can shelter current income and improve after-tax returns. These features can be a major advantage in JV structures involving capital-intensive real assets.
Liquidity and GP/LP Incentives
The general partner (GP) often controls the MLP and may earn incentive distribution rights (IDRs), creating alignment or tension depending on structure. This allows sponsors to benefit disproportionately as the venture becomes more profitable—a double-edged sword for LPs.
Comparison of REITs vs. MLPs in JV Structures
| Feature | REITs | MLPs |
|---|---|---|
| Taxation | No entity-level tax if compliant | Pass-through (no entity-level tax) |
| Investor Reporting | 1099 (simpler for investors) | Schedule K-1 (more complex) |
| Asset Requirements | Real estate only | Must generate “qualifying income” |
| Income Distribution | 90% of taxable income mandatory | No mandatory distribution |
| Capital Gains Deferral | Yes, via UPREIT/§721 exchanges | Possible but more complex |
| Flexibility in JV Terms | Restricted by REIT qualification rules | High flexibility in structuring |
| Public Market Access | Broad investor base | Institutional/high net worth favored |
Considerations for Structuring REIT or MLP JVs
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Investor Profile: Institutional investors may prefer MLPs for tax efficiency and control, while retail investors may lean toward REITs for simplicity and dividend regularity.
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Asset Type: Traditional real estate like apartments or offices favors REITs; infrastructure or energy-adjacent real estate may be suitable for MLPs.
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Control and Management: MLPs offer more flexibility in control, governance, and profit-sharing arrangements. REITs are more constrained by corporate governance standards.
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Exit Strategy: REITs provide more predictable liquidity via the public markets. MLPs may offer strong returns but involve more complicated tax treatment upon exit.
Conclusion
Both REITs and MLPs offer distinct advantages when structuring joint ventures, particularly in tax planning and capital formation. REITs are ideal for income-producing real estate and investors seeking simplicity, regular distributions, and liquidity. MLPs provide flexibility, pass-through taxation, and potentially greater tax efficiency for infrastructure-related ventures.
The choice between a REIT and an MLP structure should be driven by the nature of the underlying assets, the target investor base, and long-term tax and governance objectives. Thoughtful structuring can unlock significant value and align the interests of all JV participants.
Frequently Asked Questions
What is the primary tax advantage of structuring a real estate joint venture through a REIT?
The primary tax advantage of using a REIT structure in a joint venture is the avoidance of double taxation. REITs are generally not taxed at the corporate level as long as they meet IRS qualification criteria, such as distributing at least 90% of taxable income to shareholders and deriving at least 75% of their income from real estate-related sources.
This means that income earned by the REIT is taxed only at the shareholder level when dividends are received, rather than being taxed first at the corporate level and then again at the individual level, as with traditional C corporations. In joint ventures, this structure enables tax-efficient ownership and income distribution while allowing property contributors to potentially defer capital gains through mechanisms like 721 exchanges.
How does an UpREIT structure benefit property owners contributing assets to a REIT joint venture?
An UpREIT (Umbrella Partnership Real Estate Investment Trust) allows property owners to defer capital gains taxes when contributing appreciated real estate into the REIT’s operating partnership (OP). Instead of receiving cash or REIT shares directly (which would trigger taxable gain), contributors receive OP units, which are partnership interests that are economically similar to REIT shares but do not cause immediate tax recognition.
These OP units can typically be converted into REIT shares at a later date, giving the contributor flexibility in timing tax consequences. This deferral strategy under IRC 721 is especially valuable in joint venture structuring when combining assets from multiple owners into a tax-efficient platform.
What are the key tax compliance risks for REITs participating in joint ventures?
REITs face several tax compliance risks in joint ventures, including:
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Failing income and asset tests: A REIT must derive at least 75% of its income from real estate-related activities and hold at least 75% of its assets in qualifying real estate. Income from JV activities that don’t meet these criteria could endanger REIT status.
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Violating distribution requirements: The REIT must distribute at least 90% of taxable income annually. If JV income is retained or reinvested at the JV level without appropriate structuring, the REIT might not meet this requirement.
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Related-party transactions: Improperly structured transactions with related parties within a JV (e.g., leasing to related tenants) could result in excise taxes or disqualification.
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Prohibited transactions: JVs engaging in development and sales of real estate (e.g., flipping properties) could trigger the 100% prohibited transaction tax if not carefully planned.
To mitigate these risks, REITs often use blocker corporations or TRSs (Taxable REIT Subsidiaries) to isolate non-qualifying income and maintain REIT status.
