If you're considering a 721 exchange or UPREIT conversion, you'll end up holding operating partnership units — 'OP units' — so understanding them is essential. OP units are your ownership interest in a REIT's operating partnership, the entity that directly owns the REIT's real estate. When you contribute property in a 721 exchange, you receive OP units representing your property's value, becoming a partner in the operating partnership. These units pay distributions (like REIT dividends), represent your stake in the REIT's diversified portfolio, are convertible into REIT shares (with tax consequences), and receive a step-up in basis at death. They're the form your real estate wealth takes after a 721 exchange. This guide explains OP units in depth — what they are, how you receive them, how they compare to REIT shares, their distributions, conversion, and estate-planning role.
What are OP units?
OP units — operating partnership units — are ownership interests in a REIT's operating partnership, the entity that directly owns and operates the REIT's real estate. In an UPREIT structure, the REIT owns its properties through this operating partnership, and OP units represent partnership interests in it. When you hold OP units, you're a limited partner in the operating partnership, with an economic stake in the REIT's portfolio (held by the partnership).
OP units function as a form of REIT ownership, economically similar to REIT shares but at the partnership level. They entitle you to a share of the partnership's distributions (comparable to the REIT's dividends), reflect your proportionate interest in the REIT's real estate portfolio, and are typically convertible into REIT shares. So OP units give you the economic benefits of REIT ownership (income, appreciation exposure, diversification) through a partnership interest rather than direct REIT shares.
The key feature that makes OP units special is their role in 721 exchanges: because they're partnership interests, you can receive them tax-deferred by contributing property to the partnership under Section 721. This is why OP units are central to the 721 exchange — they're the tax-deferred form of REIT ownership you receive for your contributed property. What OP units are — ownership interests in a REIT's operating partnership, functioning as a partnership-level form of REIT ownership (with distributions, portfolio exposure, and convertibility to shares) — is the foundation for understanding the 721 exchange's result. OP units are what you hold after contributing property, your tax-deferred stake in the REIT. Understanding what they are clarifies the nature of your post-721 ownership. OP units are the partnership-level REIT ownership you receive in a 721 exchange.
How you receive OP units
You receive OP units by contributing property to the REIT's operating partnership in a 721 exchange. When you contribute your property, the operating partnership issues you OP units equal in value to your contributed property — so your property's value converts into a corresponding number of units. This contribution is tax-deferred under Section 721, so you receive the units without recognizing the gain on your property.
The number of units you receive is determined by your property's agreed value divided by the unit value (typically tied to the REIT's share price or net asset value). For example, contributing a $4,000,000 property when units are valued at $40 each yields 100,000 OP units. So your property's worth translates into a specific number of units, establishing your stake in the operating partnership. The valuation and unit determination are part of the 721 exchange process.
After receiving the units, you're a limited partner in the operating partnership, holding your OP units — your tax-deferred stake in the REIT's portfolio. This is how you transition from direct property ownership to OP unit ownership: by contributing the property and receiving units in return, tax-deferred. How you receive OP units — by contributing property to the operating partnership in a 721 exchange, receiving units equal in value to your property (tax-deferred under Section 721) — is the mechanism that gives you OP units. Your property's value becomes a specific number of units, establishing your stake. Understanding how you receive them connects the 721 exchange (the contribution) to the OP units (the result). You receive OP units as the tax-deferred consideration for contributing your property to the REIT's operating partnership.
You receive OP units by contributing property to the operating partnership — your property's agreed value, divided by the unit value, becomes a specific number of units, tax-deferred under Section 721.
OP units vs. REIT shares
Understanding how OP units compare to REIT shares is important, since they're related but distinct. OP units are interests in the operating partnership (which owns the real estate), while REIT shares are ownership of the REIT itself (which controls the operating partnership). Economically, they're similar — both reflect ownership in the REIT's portfolio, and OP units are typically convertible into REIT shares (often one-for-one). So a unit and a share generally represent comparable economic value.
The key differences are tax treatment and liquidity. On tax: holding OP units continues the tax deferral (the gain stays deferred), while converting OP units to REIT shares is generally a taxable event (triggering the deferred gain). So OP units are the tax-deferred holding, and REIT shares are the post-conversion (taxable) holding. On liquidity: REIT shares (for public REITs) are liquid and tradable on the market, while OP units are less liquid (you typically must convert them to shares to access the market, triggering the tax).
So the relationship is that OP units are the tax-deferred, partnership-level interest you receive in the 721 exchange, and REIT shares are the liquid, corporate-level interest you can convert into (triggering the tax). You hold units for deferral and income, and convert to shares for liquidity (accepting the tax). OP units vs. REIT shares — economically similar (both reflecting REIT portfolio ownership, convertible) but differing in tax treatment (units defer the gain, conversion to shares triggers it) and liquidity (shares are tradable, units less so) — is a key distinction to understand. The units are your tax-deferred holding; the shares are the liquid form you convert into. Understanding the comparison clarifies the choice between holding units (deferral, income) and converting to shares (liquidity, tax), which is central to managing your post-721 ownership.
Distributions on OP units
OP units pay distributions, providing income to unit holders. The operating partnership distributes income to its partners (including you, as a unit holder), and these distributions are typically comparable to the dividends the REIT pays its shareholders — reflecting the income from the REIT's real estate portfolio. So as an OP unit holder, you earn regular distributions, similar to what you'd earn as a REIT shareholder, providing passive income from the REIT's properties.
The distributions are a key benefit of OP units — they provide ongoing income while you hold the units (with the gain deferred). For an owner who contributed property in a 721 exchange, the distributions replace the rental income from their former property with passive distributions from the REIT's portfolio — hands-off income from diversified real estate. So you keep earning real estate income after the 721 exchange, now passively and from a diversified portfolio.
The tax treatment of the distributions (how they're taxed as you receive them) is handled per partnership and REIT tax rules, which your CPA addresses — distributions may include various components (ordinary income, return of capital) with different tax treatment. The key point is that OP units generate ongoing passive income via distributions. Distributions on OP units — regular income comparable to REIT dividends, providing passive income from the REIT's portfolio while you hold the units — are a key benefit, replacing your former property's rental income with hands-off, diversified income. Understanding the distributions shows that OP units aren't just a deferral vehicle; they generate ongoing income. The distributions are how OP units pay you while you hold them, an important part of their value as a real estate income holding.
Converting OP units (and the tax)
Converting OP units to REIT shares is a key feature, providing liquidity but triggering the tax. After a holding period (often around a year), you can typically convert your OP units into REIT shares (often one-for-one) or, in some structures, redeem them for cash. Converting to shares gives you REIT shares, which (for public REITs) are liquid and tradable — so conversion is your path to liquidity, letting you sell shares for cash.
However, converting is generally a taxable event — it triggers the deferred gain on the converted units. So converting trades the continued deferral for liquidity: you recognize the gain (and pay the tax) on the units you convert, in exchange for the liquid shares. This means conversion has a tax cost, which you should plan for. You can convert gradually (portions over time) to spread the tax and access liquidity incrementally, rather than triggering all the gain at once.
The conversion decision is thus a balance: convert for liquidity (accepting the tax) or hold for continued deferral and income (toward the step-up at death). Many investors hold the units long-term (deferring, earning income) and convert only as needed for liquidity. Converting OP units (and the tax) — converting to REIT shares for liquidity, which triggers the deferred gain (a taxable event), with the option to convert gradually to spread the tax — is a defining feature of OP units. The conversion provides liquidity but at a tax cost, so you balance liquidity needs against continued deferral. Understanding conversion and its tax clarifies how you access liquidity from OP units (by converting, taxable) versus preserving the deferral (by holding). This flexibility, with its tax trade-off, is central to managing OP units.
- OP units are ownership interests in a REIT's operating partnership — your tax-deferred stake from a 721 exchange.
- You receive them by contributing property (value ÷ unit value = units), tax-deferred under Section 721.
- OP units vs. REIT shares: economically similar and convertible, but units defer the gain while converting to shares triggers it.
- Units pay distributions (like dividends) and receive a step-up at death; converting to shares provides liquidity but triggers the tax.
OP units and estate planning
OP units offer significant estate-planning advantages, making them valuable for wealth transfer. The step-up in basis at death applies to OP units — if you hold the units until death, your heirs generally receive a stepped-up basis (reset to fair market value at your death), which can erase the deferred gain embedded in the units. So the gain you deferred (and further appreciation) can pass to heirs free of the income tax that converting or selling would have triggered. The step-up makes OP units a powerful estate-planning holding.
The divisibility of OP units is another estate advantage. Unlike a single property (hard to divide among multiple heirs), OP units are easily divisible — you can leave specific numbers of units to each heir, cleanly dividing your real estate wealth without forcing a sale or creating shared-property complications. So OP units simplify estate division among multiple heirs, a practical benefit for estate planning.
Together, the step-up (erasing the gain) and the divisibility (easing the division) make OP units exceptionally well-suited to estate planning. An owner can hold the units for life (earning distributions, deferring the gain) and pass them to heirs (with the step-up erasing the gain and the units dividing cleanly). OP units and estate planning — the step-up at death erasing the deferred gain, plus the divisibility easing the transfer among heirs — make OP units a powerful estate-planning holding, paralleling the benefits of holding 1031 property until death. The combination of erasing the gain and easing the division addresses major estate challenges. Understanding the estate role shows why OP units are especially attractive for owners focused on transferring real estate wealth to heirs tax-efficiently. The estate-planning advantages are a defining strength of OP units as a long-term holding.
How Baker 1031 helps with OP units
Baker 1031 Investments helps property owners understand OP units — what you'd receive in a 721 exchange, how they compare to REIT shares, the distributions they pay, how conversion works (and its tax), and their estate-planning role — so you understand the nature of your post-721 ownership before proceeding. We help you evaluate whether holding OP units (the tax-deferred form of REIT ownership) fits your goals.
OP units, REIT shares, and related securities are offered through the broker-dealer, Aurora Securities, Inc. (member FINRA/SIPC), and any recommendation follows a suitability review — OP units are securities, available to suitable investors after a review. We coordinate with your CPA on the tax aspects (the deferral, distributions' taxation, conversion's tax, the step-up) and your estate attorney on the estate-planning role. Our role is to help you understand OP units fully — the income, the deferral, the conversion flexibility, and the estate benefits — so if you do a 721 exchange, you know exactly what you'll hold and how to manage it. OP units are the form your real estate wealth takes after a 721 exchange, and we help you understand and manage them effectively for your goals.
Frequently Asked Questions
What are OP units?
Operating partnership units — ownership interests in a REIT's operating partnership, the entity that directly owns the REIT's real estate. In an UPREIT, the REIT owns its properties through this operating partnership, and OP units are partnership interests in it. As an OP unit holder, you're a limited partner with an economic stake in the REIT's portfolio, earning distributions (like REIT dividends), with the units convertible into REIT shares. OP units are the tax-deferred form of REIT ownership you receive in a 721 exchange — your stake in the REIT's real estate.
How do I get OP units?
By contributing property to the REIT's operating partnership in a 721 exchange — the partnership issues you OP units equal in value to your contributed property, tax-deferred under Section 721. The number of units equals your property's agreed value divided by the unit value (typically tied to the REIT's share price), so e.g. a $4,000,000 property at $40/unit yields 100,000 units. You receive the units without recognizing the gain, becoming a limited partner. So you get OP units as the tax-deferred consideration for contributing your property.
How do OP units differ from REIT shares?
OP units are interests in the operating partnership (which owns the real estate); REIT shares are ownership of the REIT (which controls the partnership). They're economically similar and typically convertible (units to shares, often one-for-one), but differ in tax and liquidity: holding units defers the gain, while converting to shares triggers it (taxable); and REIT shares are liquid/tradable (public REITs), while units are less liquid (you convert to shares to access the market). So units are the tax-deferred holding; shares are the liquid form you convert into.
Do OP units pay income?
Yes — OP units pay distributions, typically comparable to the dividends the REIT pays its shareholders, reflecting the income from the REIT's real estate portfolio. So as an OP unit holder, you earn regular passive income, similar to a REIT shareholder. For an owner who contributed property in a 721 exchange, these distributions replace the rental income from their former property with hands-off income from the REIT's diversified portfolio. The distributions are a key benefit — ongoing passive income while you hold the units, with the gain deferred.
Can I convert OP units to REIT shares?
Yes, typically after a holding period (often around a year), you can convert OP units to REIT shares (often one-for-one) or, in some structures, redeem for cash. Converting gives you REIT shares (liquid and tradable for public REITs), providing a path to liquidity. However, converting is generally a taxable event, triggering the deferred gain on the converted units. So conversion provides liquidity but at a tax cost. You can convert gradually (portions over time) to spread the tax, or hold the units for continued deferral toward the step-up at death.
Is converting OP units to shares taxable?
Yes, generally — converting OP units to REIT shares (or cash) is a taxable event that triggers the deferred gain on the converted units. So conversion trades the continued deferral for liquidity: you recognize the gain (and pay the tax) on what you convert, in exchange for the liquid shares. You can convert gradually to spread the tax over time, rather than triggering all the gain at once. To avoid triggering the gain, you hold the units (deferred) rather than converting, potentially until death (when the step-up can erase the gain). Conversion has a tax cost to plan for.
Do OP units get a step-up in basis at death?
Yes — the step-up in basis at death applies to OP units. If you hold the units until death, your heirs generally receive a stepped-up basis (reset to fair market value at your death), which can erase the deferred gain embedded in the units. So the gain you deferred (and further appreciation) can pass to heirs free of the income tax that converting or selling would have triggered. This makes OP units a powerful estate-planning holding — hold for life (deferring, earning income), then pass to heirs with the step-up erasing the gain.
Are OP units divisible among heirs?
Yes — OP units are easily divisible, unlike a single property (hard to split among multiple heirs). You can leave specific numbers of units to each heir, cleanly dividing your real estate wealth without forcing a sale or creating shared-property complications. So OP units simplify estate division among multiple heirs — a practical estate-planning benefit. Combined with the step-up (erasing the gain), the divisibility makes OP units well-suited to transferring real estate wealth to multiple heirs tax-efficiently and cleanly. The divisibility is a key estate advantage of OP units.
Are OP units liquid?
Less liquid than REIT shares directly. OP units themselves aren't typically tradable on a market; to access market liquidity, you generally convert them to REIT shares (which, for public REITs, are liquid and tradable) — but converting triggers the deferred gain (taxable). So OP units offer a path to liquidity (via conversion to shares) but aren't directly liquid, and accessing the liquidity has a tax cost. For investors, this means OP units are a longer-term, tax-deferred holding with liquidity available through (taxable) conversion. The liquidity is indirect, via conversion.
Are OP units securities?
Yes — OP units are securities, so receiving them (in a 721 exchange) and holding them involves securities, offered through a broker-dealer to suitable investors after a suitability review. This means securities regulation applies, and a financial professional assesses whether the 721 exchange (and the resulting OP units) fits your circumstances. The securities nature distinguishes OP units from direct real estate (not a security). Working with a securities-licensed professional is part of receiving and holding OP units properly, and the securities considerations (suitability, risk) apply.
How are OP unit distributions taxed?
The distributions are taxed per partnership and REIT tax rules, which your CPA addresses — they may include various components (ordinary income, return of capital) with different tax treatment, and partnership taxation can be complex (you may receive a Schedule K-1 reflecting your share of the partnership's income). The taxation of the distributions is separate from the deferred gain on your contributed property (which is triggered on conversion, not by the distributions). Your CPA handles the distribution taxation. The key point is that OP units generate income, taxed per the applicable rules.
What happens to my OP units if I do nothing?
If you hold them without converting, you continue earning distributions (passive income) with the deferred gain remaining deferred. You can hold indefinitely. If you hold until death, your heirs receive the units with a stepped-up basis (potentially erasing the gain). So doing nothing means continued income and deferral, potentially toward the step-up — a perfectly valid long-term strategy. Many investors hold their OP units long-term for the income and the eventual step-up, converting to shares only if and when they need liquidity. Holding is a sound default for the units.
Glossary
- OP Units
- Operating partnership units — your stake in a REIT's operating partnership.
- Operating Partnership
- The entity under a REIT that owns the real estate, issuing OP units.
- Limited Partner
- Your role as an OP unit holder in the operating partnership.
- REIT Shares
- The corporate, tradable ownership of the REIT, convertible from OP units.
- Conversion
- Exchanging OP units for REIT shares, generally a taxable event.
- Distributions
- Income paid on OP units, comparable to REIT dividends.
- Section 721
- The code section under which you receive OP units tax-deferred.
- Carryover Basis
- The property's basis carried into the OP units, holding the deferred gain.
- Step-Up in Basis
- The death-time reset erasing the deferred gain on OP units.
- Divisibility
- The ease of dividing OP units among heirs.
- Unit Value
- The per-unit value (tied to the REIT's share price) setting units received.
- Holding Period
- The time before OP units can typically convert to shares.
- Schedule K-1
- The tax form reporting your share of partnership income from OP units.
- Return of Capital
- A distribution component that may be non-taxable, reducing basis.
- Liquidity
- Accessed by converting units to tradable shares (taxable).
- UPREIT
- The umbrella partnership REIT whose operating partnership issues OP units.
Sources & References
- Cornell Legal Information Institute. 26 U.S. Code § 721 — Nonrecognition of gain or loss on contribution
- IRS. Publication 541, Partnerships
- Cornell Legal Information Institute. 26 U.S. Code § 1014 — Basis of property acquired from a decedent
- Nareit. What's a REIT (Real Estate Investment Trust)?
Disclosures
This article is published by Baker 1031 Investments, LLC for general educational purposes for accredited investors and is not an offer to sell or a solicitation of an offer to buy any security, nor is it tax, legal, accounting, or investment advice or a recommendation. Any securities offering is made solely through a sponsor’s private placement memorandum (PPM) following a suitability determination. Securities offered through Aurora Securities, Inc. (ASI), member FINRA / SIPC; Baker 1031 Investments is independent of ASI.
Oil & gas mineral and royalty interests and DST programs are speculative, illiquid securities sold only to verified accredited investors and involve substantial risk, including possible loss of principal, commodity-price and production-decline risk, lack of control, and the risk that an intended 1031 exchange fails to qualify for tax deferral. Whether a particular interest qualifies as like-kind real property is a fact-specific legal determination that varies by state and by the terms of the instrument. Tax results depend on your individual circumstances. Consult your own CPA and attorney before acting. Past performance does not guarantee future results.
