A REIT operating partnership is a legal structure that lets a real estate investment trust own and manage properties while keeping some flexibility in how it distributes ownership and cash flow.
Most REITs are structured as corporations, but some use an operating partnership (often called an OP or LP structure) as their main holding company. In this setup, the REIT itself owns a controlling stake in a partnership that actually holds the real estate. Individual investors, property founders, or other entities can own the remaining partnership units alongside the REIT.
The operating partnership structure matters because it changes how distributions work, how properties can be added to the REIT, and what tax treatment you receive as a shareholder. It is not better or worse than a straight corporate structure — it is a different legal path that some REITs choose for specific reasons.
Key Takeaways
- An operating partnership is a separate legal entity (usually a limited partnership) that owns the REIT's properties, with the REIT as the controlling general partner.
- Property owners can contribute real estate directly to the operating partnership in exchange for partnership units, which may defer their tax bill compared to a direct sale.
- Operating partnership units can sometimes be exchanged for REIT shares, though the timing and terms depend on the specific REIT's structure and rules.
- Distributions from an operating partnership flow through to the REIT first, then to REIT shareholders, so the tax form you receive depends on whether you own REIT shares or partnership units.
How the Operating Partnership Structure Works
In a typical operating partnership setup, the REIT is the general partner and owns a majority stake — often 90 percent or more — of the partnership. The remaining units are held by other parties: sometimes the REIT's founders, sometimes property contributors, sometimes other investors. The partnership itself holds the real estate, signs the leases, collects the rent, and pays the operating expenses.
Cash flow and distributions move from the properties to the partnership, then from the partnership to the REIT, then from the REIT to its shareholders. If you own REIT shares, you receive distributions as a shareholder and get a Form 1099 or K-1 depending on the REIT's tax status. If you own operating partnership units directly, you receive distributions as a partner and typically get a Schedule K-1 showing your share of partnership income and losses.
The REIT maintains control because it is the general partner and usually owns the majority of units. This means the REIT's board makes decisions about buying, selling, and managing properties, even though the partnership is the legal owner.
Why REITs Use Operating Partnerships Instead of Corporate Structure
The main reason is tax efficiency. A REIT must distribute at least 90 percent of its taxable income to shareholders. An operating partnership structure lets the REIT do this while still retaining some flexibility in how it handles property acquisitions and founder compensation.
Operating partnerships also make it easier to bring in property owners as partners. Instead of forcing a property owner to sell their building for cash (which triggers a capital gains tax), the owner can contribute the property to the partnership in exchange for units. This exchange is often tax-deferred under Section 721 of the Internal Revenue Code, meaning the owner does not owe tax on the gain until they later sell or exchange the units.
For the REIT, this structure makes acquisitions simpler because it can offer partnership units as part of the deal price, not just cash. For property owners, it means they can become long-term partners in the REIT rather than cashing out entirely.
Operating Partnership Units and Their Relationship to REIT Shares
Operating partnership units are not the same as REIT shares, but they are often convertible. Many REITs allow unit holders to exchange their units for REIT shares on a one-for-one basis, though the timing and conditions vary by REIT. Some REITs allow this exchange at any time; others require a waiting period or have other restrictions.
The value of a unit should track closely with the value of a REIT share because they represent the same underlying ownership claim. However, units may be less liquid — meaning harder to sell quickly — because they trade less frequently than REIT shares on public exchanges. If you own units and want to exit your position, you may need to exchange them for shares first, then sell the shares on the open market.
When a REIT pays a distribution, it typically pays the same amount per unit as per share, adjusted for the REIT's ownership stake. If the REIT owns 95 percent of the partnership, the remaining 5 percent of distributions go to other unit holders proportionally.
Tax Treatment for Operating Partnership Unit Holders
If you own operating partnership units directly (not through REIT shares), you receive a Schedule K-1 each year showing your share of the partnership's income, losses, depreciation, and other items. This is different from owning REIT shares, where you receive a Form 1099 or similar document showing only distributions.
The K-1 approach can be more complex because you must report your share of partnership income even if you did not receive it in cash. For example, if the partnership has depreciation deductions, those flow through to you on the K-1, and you can use them to offset other income. This can be valuable for tax planning, but it also means your tax return is more detailed.
When you exchange units for REIT shares, you may trigger a taxable event depending on the terms of the exchange and your cost basis in the units. Some exchanges are structured to be tax-deferred, while others are taxable. The REIT's prospectus or partnership agreement will spell out the tax consequences.
Comparing Operating Partnership Structure to Straight Corporate REITs
| Feature | Operating Partnership REIT | Corporate REIT |
|---|---|---|
| Property ownership | Held by the operating partnership; REIT is general partner | Held directly by the REIT corporation |
| Founder/contributor incentive | Can exchange property for units; tax-deferred under Section 721 | Must sell property for cash; triggers capital gains tax |
| Shareholder tax form | Form 1099 or K-1 depending on whether you own shares or units | Form 1099 or similar; no K-1 unless you own a special class |
| Unit/share convertibility | Units often convertible to shares at holder's option | Not applicable; only shares exist |
| Complexity | Higher; requires understanding partnership structure and tax flow-through | Simpler; standard corporate structure |
Neither structure is inherently better for investors. The operating partnership model is more common among larger REITs and those that have grown through acquisitions of existing properties. It tends to attract founders and property owners who want to remain invested long-term. A straight corporate REIT is simpler to understand and may be more common among smaller REITs or those that develop new properties rather than acquire existing ones.
What Happens to Operating Partnership Units When a REIT Is Acquired
If another company acquires the REIT, the acquiring company typically assumes control of the operating partnership as well. Unit holders may be offered the same deal as REIT shareholders — usually cash or stock in the acquiring company — or they may be asked to exchange their units for REIT shares first, then participate in the acquisition on the same terms as other shareholders.
The specifics depend on the acquisition agreement and the REIT's partnership agreement. Some agreements give unit holders special rights or different treatment than public shareholders. It is worth reviewing the partnership agreement if you hold units and want to understand what happens in a sale scenario.
Frequently Asked Questions
Can I buy operating partnership units directly, or do I have to own REIT shares?
Most operating partnership units are not sold to the public. They are held by the REIT's founders, property contributors, or other institutional investors. As a regular investor, you typically own REIT shares, not units. However, some REITs do allow unit holders to exchange units for shares, so if you inherit units or receive them as part of a property deal, you can usually convert them.
Do I pay different taxes if I own REIT shares versus operating partnership units?
Yes. REIT shareholders receive a Form 1099 or similar showing distributions only. Operating partnership unit holders receive a Schedule K-1 showing their share of all partnership income, losses, and deductions, even if not distributed in cash. This makes unit ownership more complex for tax purposes but can offer more tax planning opportunities through depreciation and other deductions.
What does it mean if a REIT says it is "externally managed" versus "internally managed," and does that relate to the operating partnership?
External versus internal management refers to who runs the REIT's day-to-day operations, not the operating partnership structure. An externally managed REIT hires a separate company to manage properties and make decisions. An internally managed REIT has its own staff. Both types can use an operating partnership structure; the two concepts are separate.
If I own REIT shares, do I need to understand the operating partnership structure?
Not in detail. The operating partnership is mostly a behind-the-scenes structure that affects how the REIT acquires properties and how it distributes cash. As a shareholder, you receive distributions and tax forms just as you would from any REIT. Understanding the structure helps if you are comparing REITs or trying to understand why one REIT's tax forms look different from another's.
Can an operating partnership unit holder force the REIT to buy back their units?
Typically no. Unit holders have the right to exchange units for REIT shares (if that right is in the partnership agreement), but they cannot force the REIT or partnership to repurchase units for cash. If you want to exit, you exchange for shares and sell the shares on the market. The partnership agreement will specify the exact terms and any restrictions on exchange timing.