Unlocking the UPREIT Structure: A Comprehensive Guide to LTIP Units as Currency for Incentive Equity Awards

The umbrella partnership real estate investment trust (“UPREIT”) structure, a cornerstone of the modern REIT industry, provides REITs with powerful tools for both property acquisitions and executive compensation. This article focuses on the use of long-term incentive partnership units (“LTIP Units”) as compensation currency within UPREIT structures. See our previous article in this series, “Unlocking the UPREIT Structure: OP Unit Transactions for REITs,” for an in-depth discussion of OP unit transactions for real estate acquisitions and UPREIT M&A transactions.

 

I. Introduction

The UPREIT structure offers opportunities to leverage operating partnership (“OP”) units (“OP units”) into a supremely flexible, efficient and effective currency for long-term incentive program (“LTIP”) awards. LTIP Unit awards can be designed to replicate the features of most types of equity compensation awards granted by public companies and combine time- and performance-based vesting, full value and option-like economics, and varying levels of participation in regular and special dividends and other distributions. Further, LTIP Units offer the unique advantages of partnership equity awards structured as “profits interests” for tax purposes, which can provide significant tax advantages for award recipients under current law: no taxable income at the time of grant or at the time of vesting, and taxation at capital gains rates when the award is monetized through an exchange for REIT shares or their cash equivalent.

In this article we will discuss two specific types of LTIP Units:

• LTIP Units structured to replicate the economics of full value equity awards such as restricted stock or restricted stock units (“RSUs”) granted as time-based or performance-based incentives (“FVLTIP Units”); and
• “appreciation only” LTIP Units structured to replicate the economics of stock options with a mandatory net exercise feature (“AOLTIP Units”).

Both FVLTIP Units and AOLTIP Units are a class of OP units and recipients become limited partners of the OP upon issuance. These instruments have become increasingly popular alternatives to traditional equity awards within UPREITs because they combine potentially more favorable tax treatment for recipients with full alignment with long-term value creation. Indeed, the use of LTIP Units in executive compensation has become so prevalent that REITs that do not utilize LTIP Units as part of their compensation structure may find themselves at a disadvantage when seeking to attract and retain talented executives.

The implementation of LTIP Unit programs requires careful consideration and planning with advice from experienced legal and tax advisors. As discussed further below, LTIP participants must carefully evaluate the trade-offs between comparative tax benefits and increased complexity, including multi-state filing requirements, phantom income risks and the uncertainty surrounding future legislative changes affecting carried interest treatment (discussed in Section VI below).

Disclaimer: This article does not contain a complete discussion of tax considerations relevant to FVLTIP Units or AOLTIP Units and should not be considered tax advice. All parties are strongly advised to consult with their own tax advisors.

II. Overview of FVLTIP Units and AOLTIP Units

A. Basic Structure and Economic Function

Designing, pricing and granting LTIP Units as incentive compensation follow the same basic governance, corporate and securities protocols as any other form of equity award:

• LTIP Units must be contemplated as a type of permitted award by a stockholder-approved omnibus equity incentive plan (“Omnibus Plan”). The authorizing language in the plan can take a variety of forms, ideally, but not necessarily, including a specific reference to the grant of OP units of the UPREIT;¹
• the Board or Compensation Committee, advised by compensation consultants and counsel, generally develop and approve the terms of the award (type, size, vesting, dividend participation and other conditions);
• grant date fair value² is determined with the assistance of financial advisors for reporting purposes; and
• award documentation is then drafted and executed, keeping in mind that the rights, privileges, and obligations of a holder of LTIP Units must be set forth in the limited partnership agreement of the OP, while the economic and other terms of individual LTIP Units awards will generally be set forth in an award agreement.³

LTIP Units can be used for any type of equity-based incentive program, including annual equity awards, one-time awards, retention awards, and inducement grants. Some REITs permit executives to receive all or a portion of their annual cash bonuses in the form of LTIP Units.⁴ When LTIP Units are used, recipients can be, and often are, given a choice to receive either LTIP Units or a traditional equity award. LTIP Units grants may not be appropriate for all recipients, with many REITs limiting the grant of LTIP Units to selected members of the management team rather than all employees who are eligible to receive equity incentive awards.

FVLTIP Units. FVLTIP Units serve as substitutes for restricted stock or RSUs. Generally FVLTIP Units enjoy a one-for-one correspondence with OP units once they are vested so long as they have become fully “booked up” based on priority allocations of book gain (most commonly measured by reference to appreciation in the trading price of shares of the REIT common stock from the grant date to the day book-up allocations are made). Book-up requirements applicable to FVLTIP Units are discussed in more detail in Section IV, below. After both vesting and book-up have occurred, FVLTIP Units may be converted on a one-for-one basis into common units in the OP.

Outperformance Plans. In addition to time-based awards, which provide straightforward retention incentives, REITs also use FVLTIP Units to create special incentive programs designed to retain and motivate a REIT’s senior leadership team to successfully execute strategies that create long-term value for shareholders (often referred to as “over-performance” or “outperformance” plans, or “OPPs”). OPPs have taken many forms, including:

• dollar-denominated programs that reward management for delivering total shareholder return (“TSR”) in excess of absolute and/or relative hurdles by creating a “profit-sharing pool” that is converted into FVLTIP Units after performance has been determined;
• share-denominated programs where a percentage of a target number of FVLTIP Units can be earned upon achievement of targets including absolute or relative TSR and operating metrics such as Funds From Operations (“FFO”) per share, leasing and occupancy metrics, reduction in financial leverage, property acquisition/disposition or development milestones, environmental, social and governance (ESG) goals and others; and
• programs that tie vesting to growth in FFO per share, net operating income, share price or other metrics over a set measurement period.

OPPs can be implemented on a periodic basis as part of a REIT’s ongoing executive compensation program (often with annual grants for overlapping three-year measurement periods) or as one-time awards intended to create special incentives tailored to a REIT’s strategic goals. OPPs often blend a variety of features into an LTIP program that includes (i) performance-based vesting contingent upon achievement of performance metrics that align realized compensation with company performance objectives, (ii) time-based vesting tied to continued service over a specified period, and (iii) post-vesting “no-sale” restrictions to require executives to remain at risk for the value of earned incentives over a longer period.

Many OPPs provide that the LTIP Units underlying the award can be earned at a variety of levels. In share-denominated programs there are typically minimum/target/maximum tiers, while in dollar-denominated programs usually there are floors and caps, often with vesting multipliers tied to different parameters. In either case, it is typical to issue on the grant date a number of FVLTIP Units sufficient to accommodate the highest possible level of payout the participant may achieve, plus (if applicable) additional FVLTIP Units to cover dividend catch-up payments on the units that may be earned based on performance. This conservatively large upfront grant is made to avoid the need to issue additional FVLTIP Units at the time of performance-based vesting, which units would be “unseasoned” from the different points of view discussed in detail later in this article (such as book-up allocations and holding periods).

Calculating Maximum Units. The calculation of the maximum number of FVLTIP Units that could be earned under the program often relies on estimates and assumptions as to future events, and therefore tends to inflate the nominal number of FVLTIP Units granted. This potential “over granting,” however, normally is not detrimental to the REIT and its shareholders because any units that do not become vested are automatically forfeited and the dividend equivalent rights provisions of an OPP are typically structured to offset any “extra” dividends paid on units that are later forfeited. Similarly, because the determination of grant date fair value of the awards for accounting purposes is typically based on the substance of the program’s design (often using a Monte-Carlo or similar statistical methodology), rather than the notional number of units, granting the maximum number of FVLTIP Units upfront does not increase the compensation amounts reported in the REIT’s proxy statement. The one negative effect of an “over-estimate” of FVLTIP Units granted is that shares available under the Omnibus Plan need to be reserved accordingly, thus leading to a potential depletion of capacity under the plan relative to the “realistic” number of FVLTIP Units that will be earned. Therefore REITs should monitor the utilization rate under the Omnibus Plan and be proactive to avoid a shortfall relative to shares budgeted for future awards before the plan can be replenished with shareholder approval.⁵

AOLTIP Units. AOLTIP Units generally permit holders to realize the benefit of an increase in the per share value of a REIT’s common stock above the value of the stock at the time the AOLTIP Units are awarded, and are typically structured so as to mirror the economics of a net exercise of a stock option. AOLTIP Units are generally convertible into a variable fraction of an LTIP Unit based on the extent of appreciation in the trading price of the REIT’s common stock from the grant date to the date of conversion.⁶ Once AOLTIP Units become vested, they can be converted into common units at a time chosen by the holder during a period that in effect replicates the term of a traditional stock option, with the AOLTIP Units converting into whatever number of common units is calculated by standard “in-the-money” math on a net exercise basis.

Partnership Interests; Conversion to Common Units. Both FVLTIP Units and AOLTIP Units are intended to constitute “profits interests” for U.S. federal income tax purposes, which provide recipients with more favorable tax treatment than equivalent equity awards in a non-partnership structure. Recipients of LTIP Units become limited partners in the OP upon receipt of the units, typically by signing a joinder to the OP’s limited partnership agreement. Because the conversion from LTIP Units into common units is not a taxable event, some OPs automatically convert LTIP Units into common units upon satisfaction of vesting and book-up conditions (unless such conversion would cut short the conversion period of an AOLTIP Unit and therefore adversely impact the “option value” of that award). Once LTIP Units have been converted to common units, such common units may, in turn at any time at the holder’s election, be redeemed for the cash value of one share of the REIT’s common stock or, at the REIT’s election, exchanged for one share of REIT common stock.

B. Benefits and Disadvantages of LTIP Units as Compared to Traditional Equity Awards

The primary advantages of LTIP Units over traditional awards of restricted stock, RSUs and stock options are tax-driven, and include the following:

Tax Deferral: Recipients of LTIP Units generally will not be taxed on the value of the award until they dispose of the LTIP Units, or the common units into which the LTIP Units may be converted, upon exchange for common stock or redemption for cash (i.e., no taxation upon issuance, vesting or conversion of LTIP Units into common units). Conversely, recipients of restricted stock and RSU awards are generally taxed at ordinary income rates on the full value of the shares on the date of vesting (for restricted stock, if no Section 83(b) election is made) or settlement (for RSUs and for restricted stock if a Section 83(b) election is made) and recipients of non-qualified stock options are taxed at ordinary income rates on the full value of any appreciation upon exercise. Like LTIP Units, incentive stock options may permit tax deferral beyond exercise if certain conditions are met.

Capital Gains Treatment: Generally, gain realized upon disposition of converted common units, either by exchange for REIT stock or redemption for cash, will be considered capital gain (although, as discussed in more detail below, long-term capital gain treatment may apply only to units (or portions thereof) treated as held for more than three years for tax purposes).⁷

The primary disadvantages of LTIP Units are increased administrative burdens and tax preparation complexity as well as, in the case of FVLTIP Units, a risk that the units will never satisfy the book-up condition (as noted above and discussed in Section IV below), and therefore may never have any realizable economic value. In addition, as discussed in Section VI, below, there is a risk of phantom income in the event of certain allocations of income without corresponding distributions and generally a two-year minimum holding period.

C. Comparative Summary: Traditional Equity Compensation vs. LTIP Units

The following summaries assume a minimum holding period of more than two years for all LTIP Units and that all LTIP Units are respected as safe harbored profits interests for U.S. federal income tax purposes, as further discussed in Section VI below.

Restricted Stock vs. FVLTIP Units

Feature	Restricted Stock (assuming no Section 83(b) election)	FVLTIP Units
Issuance	Non-taxable event	Non-taxable event
Vesting	Taxed as compensation at ordinary income rates (i.e., W-2 reporting, tax withholding and FICA and Medicare taxes apply for employees) on the full value of the vested stock, less any amount paid for the stock	Non-taxable event
Exercise/Conversion to Common OP Units	N/A	Generally a non-taxable event
Dividends/Distributions	Dividends on unvested stock are taxable as compensation (i.e., W-2 reporting, tax withholding and FICA and Medicare taxes apply for employees) and not eligible for the temporary 20% deduction for “qualified REIT dividends.” Dividends on vested stock are taxed in the same manner as they are for all stockholders	Operating income and capital gains allocated to vested and unvested FVLTIP Units are taxed as ordinary income and capital gains, respectively (whether or not distributions are made), depending on the character of the income to the OP
Disposition	Incremental appreciation since vesting is taxed as capital gains. Long-term capital gains to the extent treated as held for more than one year from vesting date	Generally, taxed as capital gains on the full value (except with respect to certain “unrealized receivables” and “inventory” items held by the OP and reduced by any tax basis allocable to the units transferred), and, under the carried interest rules, long-term capital gain to the extent treated as held for more than three years
Liquidity	Immediately saleable common stock upon vesting	FVLTIP Units are non-transferable prior to conversion, and common units issued upon conversion are generally non-transferable until two years from grant date, after which they are exchangeable for common stock or cash equivalent
Voting Rights	Vested and unvested shares are outstanding REIT common stock and may be voted at REIT stockholders meetings	FVLTIP Units typically have no voting rights at REIT stockholders meetings; do not have a guaranteed right to acquire shares of stock (i.e., must convert into common units first that may be settled in REIT stock or cash)

Non-Qualified Stock Options vs. AOLTIP Units

Feature	Non-Qualified Stock Options8	AOLTIP Units
Issuance	Non-taxable event	Non-taxable event
Vesting	Non-taxable event	Non-taxable event
Exercise/Conversion to Common OP Units	Spread value (the difference between the exercise price and the fair market value of the shares on exercise) is compensation income taxed at ordinary income rates (i.e., W-2 reporting, tax withholding and FICA and Medicare taxes apply for employees)	Generally a non-taxable event
Disposition	Incremental appreciation since exercise taxed as capital gains, long- or short-term depending on the holding period	Upon disposition of safe harbored AOLTIP Units (or converted common units), holders generally recognize capital gain/loss equal to amount realized minus tax basis (except with respect to certain “unrealized receivables” and “inventory” items held by the OP), subject to three-year holding period requirements for carried interest to obtain long-term capital gain treatment
Distributions Prior to Exercise/Conversion	N/A. Generally, no dividend equivalent rights prior to option exercise	Prior to conversion, AOLTIP Units typically receive distributions per unit equal to 10% of distributions per common unit on a current basis
Liquidity	Immediately saleable common stock upon exercise	AOLTIP Units are non-transferable prior to conversion, and common units issued upon conversion are generally non-transferable until two years from grant date, after which they are exchangeable for common stock or cash equivalent
Voting Rights	No voting rights at REIT stockholder meetings prior to exercise	No voting rights at REIT stockholders meetings

III. Implementation and Structuring Considerations

REITs implementing LTIP Unit programs should consider several factors in determining appropriate program scope and structure:

A. Participant Eligibility

The profits interest safe harbor requirements (discussed below in Section IV.A) include that the property be received for the provision of services to or for the benefit of a partnership in a partner capacity or in anticipation of being a partner. This aspect requires careful consideration of which employees and service providers are eligible to receive grants. In practice, many REITs limit participation to only a fairly limited group of executive officers who receive significant amounts of their annual compensation in the form of incentive equity awards, and therefore stand to recognize the greatest benefit from tax efficiency. However, it is not uncommon for REITs to also permit directors, consultants and less senior employees to elect to receive LTIP Units in lieu of traditional equity incentive awards.

Regardless of the overall scope of the program, REITs should ensure that award agreements clearly establish the service relationship that supports the profits interest characterization and consider whether additional service agreements are necessary. The tax advantages and complexity of LTIP Units should also be weighed against the organization’s broader compensation objectives and participant sophistication levels.

B. Employer Entity Considerations

Employer entity considerations must be addressed to determine which entity within a corporate structure should employ the recipients of LTIP Unit. If recipients of LTIP Units are employed directly by the OP, their status as limited partners (by virtue of holding LTIP Units) may be viewed as inconsistent with employee status for tax purposes. To mitigate this risk, many REITs structure their organizations so that LTIP Unit recipients are employed by a subsidiary entity that is a separate taxpayer from the OP, rather than by the OP itself. This allows recipients to maintain employee status for purposes of: (i) tax withholding on salary and cash bonuses, (ii) participation in qualified retirement plans, and (iii) eligibility for pre-tax health and welfare benefits. Alternatively, the OP may treat such recipients as independent contractors who receive guaranteed payments for services and are required to pay self-employment tax.

The specific structure should be reviewed with legal and tax advisors to ensure it achieves the intended objectives while complying with applicable laws. In REITs with complex organizational structures, coordination between the REIT, the OP, and subsidiary entities is essential to ensure proper documentation and tax treatment.

C. Transfer Restrictions

Transfer restrictions are critical to preserving the tax benefits of LTIP Unit programs. In general, holders are not permitted to exercise the redemption rights with respect to common units issued upon the conversion of LTIP Units until at least two years after the LTIP Units were issued, unless otherwise agreed. The OP agreement will typically also include transfer restrictions applicable to limited partnership interests generally, which will outline permitted transfers and the process by which a new holder may become either an assignee of the partnership interests or a substituted limited partner.

Permitted transfers typically include direct or indirect transfers of vested LTIP Units by gift or domestic relations order to family members, family trusts and other estate planning vehicles. However, care should be taken in structuring and documenting any such transfers to ensure that the interests of the REIT and the partnership are protected and that there are no adverse tax consequences for the holder. Transfers to revocable “grantor” trusts in which the OP Unit holder is the taxpayer are arguably not subject to the two-year holding requirement.

D. Grant Sizing and Book-Up Methodologies

The economic value of FVLTIP Unit is contingent upon future appreciation above the applicable highwater mark (discussed below in Section IV.C ) coinciding with a book-up event. AOLTIP Units are subject to a different book-up regime and are not tied to a highwater mark. The complexities of book gain allocations increase when an OP has multiple LTIP Unit programs active, and each program issues tranches of FVLTIP Units and/or AOLTIP Units as incentive awards over time. REITs should develop, and communicate to LTIP Unit award recipients, the capital account management policies and methodologies that drive different risk/reward profiles for different recipients, particularly if the recipients are given a choice between LTIP Units and non-partnership awards.

IV. FVLTIP Units: Key Features and Mechanics

A. Profits Interest Structure

FVLTIP Units are generally structured to meet the requirements of certain IRS “safe harbor” revenue procedures with respect to “profits interests,” although such treatment cannot be assured, particularly if there is no highwater mark as discussed below in Section IV.C.⁹ The safe harbor requirements include: (i) not being disposed of or transferred by the recipient within two years of grant, (ii) not being issued by a publicly traded partnership, (iii) not relating to a substantially certain and predictable stream of income from partnership assets (i.e., subject to sufficient entrepreneurial risk), and (iv) being received for the provision of services to or for the benefit of the issuing partnership in a partner capacity or in anticipation of being a partner. Implicit in the revenue procedure safe harbor is a further requirement that the grant of an LTIP Unit (or the special allocation of book gain to a FVLTIP Unit discussed below) is not treated as disguised compensation under general federal income tax principles that focus on factors such as the presence of sufficient “entrepreneurial risk.”¹⁰ Also implicit in profits interest treatment is that the OP, and therefore the REIT, cannot deduct the value of LTIP Units in computing its taxable income either at the time of grant or at the time of vesting. Accordingly, the impact on the REIT’s taxable income and therefore its minimum required dividend payments for REIT qualification purposes is different from non-partnership equity awards such as restricted stock, RSUs or stock options.

B. Book Capital Account, Book-Up Events and Valuation

LTIP Units generally are governed by a sophisticated system to manage the OP’s book capital accounts such that the “right” LTIP Units attract priority allocations of available book gain in the “right amount” at the “right time” to reach their target economic value. As a basic matter, the value of an FVLTIP Unit is determined by the “book capital account” balance associated with such FVLTIP Unit in connection with the OP’s taxation as a partnership.¹¹ The book capital account balance of an FVLTIP Unit when issued is initially zero (assuming no capital contributions) and each FVLTIP Unit has a specific “target” capital account balance that, when reached, will give that FVLTIP Unit one-for-one parity with a common unit. Such parity, subject to vesting, will allow the holder to, convert the FVLTIP Units into common units and, at a time of his or her choosing, subsequently exchange those common units for REIT shares (or their equivalent value in cash at the REIT’s option).

Special allocations of “book gain” subsequent to the issuance of every LTIP Unit will be situation-dependent: each LTIP Unit will have its own characteristics as a matter of partnership taxation, and the book gain allocation system will have to be structured and administered in such a way as to fairly allocate available gain to the LTIP Units that need it upon the occurrence of each book-up event. Book gain is allocated upon the occurrence of a “book-up event,” representing a change to the OP’s equity capitalization. These events include:

• Sales of equity by the REIT (and the contribution of the sales proceeds to the OP for OP Units) or the OP in more than a de minimis amount
• Acquisitions of assets by the OP in exchange for partnership units
• Issuances of more than a de minimis number of LTIP Units or shares of restricted stock (with a matching issuance of OP Units by the OP)
• Redemptions by the OP of more than a de minimis amount of OP Units for cash (including redemptions of common units that occur in connection with redemptions of shares of common stock for cash)

There is no clear definition of “de minimis” in this context. Generally the IRS favors requiring book-ups, which should weigh in favor of treating relatively small business-driven transactions as being “more than de minimis.” It is important that, whatever the OP selects, it should be applied on a consistent basis.

Upon a book-up event, the OP will measure the fair value of its assets, generally by reference to the price of a share of the REIT’s common stock as reported by the stock exchange on which the shares are listed, but may instead on a consistent basis also use other valuation methods.¹² To the extent the fair value has increased from the date of the most recent prior book-up event, there will be book gain available to be allocated to existing holders of OP units, with LTIP Unit holders entitled to priority special allocation of this book gain as needed to bring their book capital account balances to the appropriate level.¹³ Priority allocations are not necessarily made either pro rata among outstanding LTIP Units that need book-gain or by reference to how long a given LTIP Unit has been outstanding, as older FVLTIP Units may be ineligible for an allocation upon any given book-up event whereas more recently issued FVLTIP Units may be eligible (or vice versa).

C. Highwater Mark Provisions

So called “highwater mark” provisions are a standard feature of FVLTIP provisions in OP agreements. These provisions are intended to support the entrepreneurial risk required to qualify for profits interest treatment for tax purposes by restricting and limiting the special allocations of book gain to LTIP Unit holders that may be used to achieve the target book capital accounts needed to make FVLTIP Units economically equivalent to common units. Specifically, under these provisions, book gain generally will not be specially allocated on a priority basis to an FVLTIP Unit unless and until the REIT stock price on the date of such allocation exceeds the REIT stock price on the date of grant (i.e. the highwater mark).

In practice these highwater mark provisions condition a “booking up” of FVLTIP Units to the occurrence of a book-up event at a point in time when the REIT’s stock price exceeds the stock price on the grant date of the FVLTIP Units, although typically there is no time limit for reaching the “target” capital account balance, so that holders of FVLTIP Units may have opportunities to “book up” even following their departure from the REIT. While the absence of a time limit should increase the likelihood that FVLTIP Units can reach one-for-one parity with OPUs so that their full value can be realized, were the REIT’s stock price to remain below the highwater mark, vested FVLTIP Units would not reach such one-for-one parity.

D. Conversion and Redemption Rights

Once an FVLTIP Unit has reached its target book capital account balance and has fully vested, it will be eligible to convert into a common unit. As noted above, while FVLTIP Units cannot be directly converted into shares of common stock of the REIT, the common units into which FVLTIP Units are converted may be redeemed for the cash value of one share of the REIT’s common stock or, at the REIT’s election, exchanged for one share of REIT common stock, subject to any limitations set forth in the partnership agreement. Both redemption for cash and exchange for REIT stock are taxable transactions for the holder. In most cases the operative documentation (either the partnership agreement or the award agreements for the FVLTIP Units) are drafted to permit a holder to give notice of conversion of FVLTIP Units into common units and redemption of as-converted common units simultaneously, thus reducing the risk of fluctuations in the value of REIT common stock once a holder has decided to monetize a particular set of his or her FVLTIP Units. Managing exposure to price fluctuation is typically important because recipients wish to match the realization of taxable gain with the actual receipt of funds from monetization of their award.

In general, the operative documentation will provide that holders of FVLTIP Units may not exercise their redemption right with respect to common units issued upon the conversion of FVLTIP Units until at least two years after the issuance of such FVLTIP Units, unless otherwise agreed by the OP. Similar to the highwater mark construct above, this restriction is intended to support the profits interest analysis by aligning the terms of FVLTIP Units with the requirements of the safe harbor.¹⁴

E. Distribution Entitlements

FVLTIP Units, to the extent eligible, receive distributions from the OP rather than dividends from the REIT, though the distributions payable on one vested FVLTIP Unit are typically identical to the dividends paid on one share of REIT stock. There are a wide range of possible approaches to distribution rights for FVLTIP Units. Frequently, the awards are structured to track the dividend or dividend equivalent rights associated with corresponding equity award types. For example, just as REIT time-based restricted stock awards often receive full dividends paid on shares of the REIT’s common stock during the vesting period, holders of time-based FVLTIP Units will most often receive regular distributions and other non-liquidating distributions with respect to these FVLTIP Units equal on a per unit basis to the distributions paid to the holders of an equal number of common units, which are equal to the dividends and other distributions paid to the holders of an equal number of shares of common stock of the REIT.

FVLTIP Units subject to performance-based vesting are generally treated differently with respect to distributions than RSU awards are treated with respect to dividends. Where RSUs often are accompanied by dividend equivalent rights that entitle the grantee to a 100% catch-up dividend payment at settlement with respect to earned units, performance-based FVLTIP Units typically are entitled to fractional distributions (typically 10%, contrary to 100% for a time-based FVLTIP Unit) during the performance period. While only a portion of the performance-based FVLTIP Units may vest, every issued FVLTIP Unit is typically allocated some amount of ordinary partnership income to support its treatment as a presently granted partnership interest, thus starting the clock on the two-year and three-year holding periods discussed elsewhere. The fractional allocation can, but is not always, matched by a corresponding fractional distribution. Some REITs choose to allocate fractional taxable income without a matching distribution, which likely results in a tax burden for the recipient who must pay taxes on the fractional income allocation without receiving any cash, and in fact might never realize the value of the relevant FVLTIP Units if they do not become vested or never satisfy the book-up requirements.¹⁵

Assuming that a performance-based FVLTIP Unit receives distributions equal to 10% of the full common stock dividend until it is earned (i.e., performance-based vesting has occurred, even if such FVLTIP Unit remains subject to service-based vesting), once the number of earned FVLTIP Units has been determined, the holder typically is eligible to receive a catch-up distribution (payable in cash or, to further maximize tax efficiency, in additional FVLTIP Units), with the catch-up amount reduced by the amount of any distributions previously paid during the performance period (counting both the distributions paid with respect to the earned FVLTIP Units and the forfeited FVLTIP Units).¹⁶ This adjustment for “over-payment” of distributions on account of performance-based FVLTIP Units that never vest is particularly meaningful in the case of OPPs, because, as discussed above, often a large number of FVLTIP Units are issued on the grant date and forfeiture of some significant number of units is highly probable.

F. Corporate Events and Related Adjustments

Change of Control Transactions.

The award documentation generally spells out the treatment of LTIP Units upon a transaction (such as an acquisition of the REIT) as a result of which common units are converted into or exchanged for the right to receive cash, securities or other property (a “Change of Control Transaction”). There is a broad range of options with respect to accelerated vesting, computations involving performance vesting hurdles, and what happens if the successor entity chooses to assume or substitute (or not assume or substitute) the REIT’s LTIP Units. No single model fits all situations and the issues can be very nuanced in the case, for example, of OPPs where a Change of Control Transaction may cut off the opportunity for full vesting earlier than anticipated. While these issues are beyond the scope of this article, it is not unusual for award documentation to provide that, in connection with a Change of Control Transaction, the REIT will use commercially reasonable efforts to enter into an agreement with any successor or acquiring entity that will (i) contain provisions enabling the holder to convert any LTIP Units that are not automatically converted in the transaction into securities as comparable as reasonably possible under the circumstances and (ii) preserve as far as reasonably possible under the circumstances the distribution, special allocation, conversion and other rights of the LTIP Units.

Upon a Change of Control Transaction, vested FVLTIP Units with book capital account balances that have reached the target book capital account balance (or that will reach such target balance after taking into account any allocations that occur in connection with the transaction or that would occur in connection with the transaction if assets of the OP were sold at a value consistent with the transaction) are typically converted into common units immediately prior to the transaction, and therefore participate in the Change of Control Transaction on the same terms and conditions as common units generally. However, if automatic conversion of LTIP Units occurs, the holders of FVLTIP Units that have not been fully booked up, and therefore may not be converted into common units on a one-for-one basis, will suffer an economic loss that they would not have suffered if the award had been in the form of restricted stock. A forced conversion may also have an adverse impact on a holder of LTIP Units if it causes the LTIP Units to fail to satisfy the (i) two-year IRS safe harbor holding period requirement or (ii) three-year holding period for long-term capital gains imposed as a result of the carried interest rules.

Stock Splits, Distributions, Recapitalizations and Similar Adjustments.

The OP’s partnership agreement typically provides for adjustments to LTIP Units in connection with stock splits, reverse stock splits, stock dividends and similar fundamental corporate events affecting the REIT’s common stock. These adjustments are designed to preserve the economic value and conversion rights of LTIP Units. Key adjustment mechanisms include: (i) the ratio at which LTIP Units convert into common units may be adjusted to reflect stock splits or combinations, (ii) the number of shares issuable upon redemption of common units may be adjusted proportionately and (iii) the book capital account balance required for full book-up may be adjusted to reflect changes in the REIT’s capitalization.¹⁷ Depending on the circumstances, these adjustments may not be as straightforward as so-called “anti-dilution adjustments” in a typical convertible or exchangeable instrument.

Special distributions, spin-offs and recapitalizations also require careful analysis to determine their impact on LTIP Units. The partnership agreement should address (i) whether LTIP Units participate in special distributions on the same basis as common units, (ii) how extraordinary distributions affect book capital accounts and the highwater mark, (iii) the treatment of spin-off securities or other non-cash distributions and (iv) adjustments to conversion rights and redemption mechanics.¹⁸

V. AOLTIP Units: Key Features and Structure

A. Option-Like Compensation

AOLTIP Units were developed as an addition to the UPREIT compensation toolkit. Historically, FVLTIP Units and their traditional equity incentive analogues (i.e., restricted stock and RSUs) provided better alignment with the REIT business model than stock options because REIT stocks offered steady dividend income and low volatility. In such a scenario, FVLTIP Units are a more attractive currency for incentive compensation due to a relatively smaller potential for equity upside of the kind that stock options are meant to capture. However, with REITs trading for significant periods at a discount to perceived net asset value, option-like awards became more favored as currency for REIT incentive compensation because of the increased potential upside value they offer under higher volatility scenarios. AOLTIPs were therefore developed to provide REIT compensation committees with an instrument suitable to harness both the tax efficiency of an LTIP Unit and the growth potential of a stock option to deliver a powerful form of incentive compensation in the right circumstances.

Like stock options, AOLTIP Units derive their value solely from the appreciation of a REIT’s stock price between the grant date and conversion of AOLTIP Units into common units.¹⁹ At grant, the Board or the compensation committee of the REIT establishes the “conversion threshold” (equivalent in substance to the exercise price of a stock option), as well as vesting terms and a “mandatory conversion date” (equivalent to the expiration date of a stock option). The conversion threshold typically equals the value of a common unit on the grant date, which generally equals the fair market value of one share of the REIT’s common stock on such date.²⁰ Similar to performance-based FVLTIP Units, and for the same tax reasons, AOLTIP Units are typically entitled to allocations and/or distributions equal to 10% of the dividend paid on the REIT’s common stock until converted to common units, and 100% thereafter. Ordinarily there is no provision for a catch up payment of the 90% balance of allocations and/or distributions, consistent with the economics of standard stock options. While most AOLTIP Units are structured to mirror traditional stock options, it is worth noting that these similarities are customary rather than required, and REITs have flexibility to customize the terms of AOLTIP Unit awards, sometimes without being confined by the requirements of traditional stock options.

B. Book Capital Account, Book-Up Events and Valuation

The value of an AOLTIP Unit is not tied to its book capital account or the occurrence of book up events when the stock price exceeds the highwater mark. Nonetheless, AOLTIP Units generally attract allocations of book gain that reflect the appreciation in the value of a common unit (typically by reference to the value of a share of the REIT’s common stock) from the grant date. In other words, the amount of aggregate gain allocated from time to time to an AOLTIP Unit is generally equal to the net “in the money” value of each unit at the time a book-up event occurs. However, insofar as the value of an AOLTIP Unit is derived entirely from appreciation in the price of a share of REIT common stock above the grant date stock price (i.e. the conversion threshold) on the conversion date, they only have value if the REIT’s common stock has achieved a net increase in value and thus do carry the kind of “entrepreneurial risk” required by the profits interest safe harbor.

C. Conversion and Forfeiture Provisions

Typical AOLTIP Units, once vested, may be converted into common units by delivering a conversion notice to the OP. If not converted prior to the mandatory conversion date, AOLTIP Units automatically convert into common units on that date (typically after a term of five or ten years). If the OP’s asset value per common unit on the mandatory conversion date is less than the conversion threshold, then the conversion ratio will be zero, which effectively means that the AOLTIP Units will be forfeited for no value.

As noted above, each AOLTIP Unit converts into a fraction of a common unit based on the conversion threshold. Effectively, in most cases, this amount is equivalent to a net exercise of an equal number of stock options struck at the conversion threshold. For example: converting 1,000 AOLTIP Units with a $10 conversion threshold when the REIT’s trading price is $20 per share results in 500 common units (($10 spread × 1,000 units) ÷ $20 value per share).²¹

D. Liquidity Mechanisms

Unlike stock options, AOLTIP Unit holders do not receive company common stock immediately upon exercise/conversion. Instead, AOLTIP Units convert first into common units, which then have the same redemption right as all other common units. Similar to FVLTIP Units, the OP agreement or the award agreements for AOLTIP Units will typically provide that holders may not exercise the redemption right with respect to common units issued upon conversion of AOLTIP Units until at least two years after the original AOLTIP Unit issuance date, unless otherwise agreed. This two-year holding period is important to the treatment of the AOLTIP Units as profits interests for tax purposes.

VI. Additional Tax and Legal Considerations

In addition to the structuring issues discussed earlier in this article, the implementation of an LTIP Unit compensation program requires careful attention to a number of other technical tax and legal considerations

This article is not intended to provide a complete summary of the complex partnership tax rules and associated tax risks that apply to UPREITs and LTIP Units. Accordingly, this section is intended only to highlight certain key considerations that holders of LTIP Units typically encounter in connection with the receipt of LTIP Units. Unless otherwise noted, this discussion is limited to LTIP Units that qualify for profits interest treatment for federal income tax purposes. All parties are strongly advised to consult with their own tax and legal advisors when receiving, transferring, or disposing of LTIP Units.

A. Partnership Tax Implications

A holder of both FVLTIP and AOLTIP Units will be taxed as a limited partner of the OP under the tax rules applicable to partnerships generally. Recipients will typically begin participating in the income, profits and distributions of the OP immediately upon issuance of the LTIP Units, regardless of whether the LTIP Units are vested and regardless of the book capital account balance associated with them. Because holders of LTIP Units will be partners of the OP, they may be required to file income tax returns (and pay taxes, including estimated tax payments) in each of the various jurisdictions in which the OP does business, owns property and/or generates income.

The rates in those states may be higher than the rates of the state in which the holder is resident and the holder may not receive a full credit against taxes in his or her state of residence for the taxes paid to other states as a result of owning LTIP Units. Holders of LTIP Units will likely face increased complexities in their income tax returns in the various jurisdictions; in some jurisdictions, the OP often does not choose to file a composite tax return (which would eliminate the need for holders to file an individual return in that jurisdiction), and the OP may be unable to do so in all jurisdictions.

B. Phantom Income Risks

Phantom income is taxable income allocated to a limited partner on which they must pay taxes even though they do not receive matching cash distributions from the OP. Due to the special allocations of book gain that are made to holders of LTIP Units to facilitate the book-up requirements, holders are more likely to receive phantom income in connection with the sale of assets by the OP in taxable transactions.

Disproportionate gain allocations to holders of LTIP Units are possible if (i) a book-up event has occurred in which the LTIP unitholder was allocated a disproportionate share of the OP’s book gain in order to build the book capital account balance associated with the LTIP Units and (ii) after the book-up event, the OP sells in a taxable transaction one or more of its assets that were booked up. In that case, those LTIP unitholders will be allocated an increased portion of the taxable gain recognized in the taxable sale transaction to reflect the disproportionate share of the book gain attributable to the sold asset that was previously allocated to them. If that disproportionate allocation occurs, each affected LTIP unitholder’s share of the taxable gain likely will exceed the share of cash proceeds from the sale that may be distributed to them, and it is even possible that their tax liability will exceed the cash distributed to them.

These risks are further increased in the case of performance-based FVLTIP Units and AOLTIP Units in situations where a company does not match the 10% allocations required to preserve the profits interest treatment with a corresponding 10% distribution participation right, resulting in a “naked” allocation of taxable gain. As a result, the holder may receive aggregate distributions lower than both the taxable gain allocated and taxes owed, requiring funding of tax payments from sources other than LTIP Unit distributions.

C. Carried Interest Rules

In addition to the two-year holding period noted above for profits interests generally under the IRS revenue procedure safe harbor, under special rules applicable to profits interests commonly referred to as “carried interests,” the minimum holding period required to obtain long-term capital gain treatment is three years (compared to the regular long-term capital gains holding period of more than one year). Although the regulations do not provide clear guidance as to whether LTIP Units are intended to be subject to the carried interest rules, the carried interest regulations appear to apply to both FVLTIP Units and AOLTIP Units, and the following discussion assume all LTIPs are subject to the carried interest rules.

The carried interest rules incorporate generally applicable holding period rules, and those rules determine how the three-year holding period requirement applies to an LTIP unitholder who has received multiple grants of partnership interests (e.g., FVLTIP Units or AOLTIP Units) if some but not all LTIP Units have been held for more than three years. As a general matter, the holding period for LTIP Units is determined under the general rules regarding capital gain holding periods for partnership interests, which do not allow holders to trace holding periods for different tranches of LTIP Units based on their respective issue dates, but rather create blended holding periods across tranches and classes. If a holder has held some FVLTIP Units, AOLTIP Units or common units for less than three years, these “blending” rules would re-characterize a portion of the gain from the disposition of LTIP Units held for more than three years as gain from units held for less than three years.

D. Section 83(b) Elections

A Section 83(b) election is a tax election that allows a recipient of property subject to a substantial risk of forfeiture (such as unvested restricted stock or LTIP Units) to elect to recognize income at the time of grant rather than at vesting. For traditional equity awards, this election can provide significant tax benefits if the property appreciates between grant and vesting because taxable income would otherwise be recognized upon vesting.

Assuming the LTIP Units meet the safe harbor requirements of the revenue procedures with respect to profits interests discussed elsewhere in this article (including that the holder does not dispose of their LTIP Units within two years from the grant of the LTIP Units), a Section 83(b) election would not affect the tax treatment to the holder under current law. This approach is consistent with how REITs typically expect to treat LTIP Units for reporting purposes.

However, if the IRS successfully asserted that the LTIP Units did not meet all of the safe harbor requirements to qualify as a profits interest, then the tax treatment of the LTIP Units would not be clear and could vary based on whether or not the holder made a Section 83(b) election:

• With Section 83(b) Election: The holder will recognize compensation income at the time of grant in an amount equal to the excess of the value of the property at that time over the amount paid for such property, but will not recognize any additional taxable income upon vesting. However, in the event that the holder forfeits the property, the holder will not be able to recognize a loss in excess of the amount that they paid for such property at the time of grant or otherwise recoup the taxes that they paid upon grant based on the full value of such property at that time. Depending on the facts (including which safe harbor requirements were not met), there may be an argument that the taxable value of an LTIP Unit on the date of grant is its liquidation value of $0.
• Without Section 83(b) Election: The holder should not recognize taxable income at grant. However, the holder may recognize taxable income upon vesting based on the excess of the value of the property at that time over the amount paid for such property. The recipient may not be treated as a partner for tax purposes until vesting.
• Current Practice: Many REITs require recipients to make so-called “protective” 83(b) elections with respect to some or all of their LTIP Units. Specifically, many REITs (i) require holders to make 83(b) elections for time-based vesting LTIP Units, and (ii) give holders the option whether to make 83(b) elections for performance-based vesting LTIP Units. In developing an LTIP program and upon receipt of an LTIP Unit, REITs and recipients of LTIP Units should weigh the pros and cons of a “protective” 83(b) election for themselves. In each case, the recipient must make the election within 30 days after the applicable LTIP Units are granted.

E. Legislative Developments. Future legislative, regulatory and/or administrative guidance could adversely impact the tax treatment of LTIP Units. Future legislation could be enacted that is more adverse to LTIP Units than the rules discussed in this article. For example, various legislative proposals introduced in the past would have taxed gain on dispositions of LTIP Units as ordinary income regardless of the holding period. It is uncertain whether or when any additional legislation or IRS guidance may be enacted or issued, what provisions the final form of such legislation or guidance would contain, when they would be effective and whether they would apply to LTIP Units.

F. Securities Law Compliance

Liquidity

As a general matter, REIT shares received upon conversion of LTIP Units and the subsequent redemption of OP units can be sold through brokers subject to federal and state securities law compliance, with “affiliates” of the REIT (including Section 16 insiders) only able to reoffer or resell shares pursuant to Securities Act exemptions (such as Rule 144) or separate prospectus coverage. Companies should establish clear procedures for compliance with securities laws, including Rule 144 requirements for affiliates.

Section 16 Reporting

Section 16 reporting requirements apply to LTIP Units. Generally, the initial grant of FVLTIP Units and subsequent conversions, redemptions and dispositions must be reported on Form 4. The conversion of FVLTIP Units into common units and the exchange of common units for REIT shares or redemption for cash also triggers reporting. AOLTIP Units have their own reporting requirements, which are generally in line with the reporting obligations for stock options.

REIT Reporting and Disclosure Requirements

REITs granting LTIP Units must provide disclosure in their proxy statements similar to other forms of equity compensation, including: a description of the awards in the Compensation Discussion & Analysis, grant date fair value in the Summary Compensation Table and Grants of Plan-Based Awards Table, holdings in the Outstanding Equity Awards at Fiscal Year-End Table, and vesting and realized value in the Option Exercises and Stock Vested Table. The REIT’s beneficial ownership table is typically modified to show not only the shares of stock but also OP unit holdings, including LTIP Units. When issuing LTIP Units as part of an Omnibus Plan, REITs must also comply with prospectus delivery requirements and typically provide recipients with a detailed disclosure document that supplements the prospectus delivered with all equity awards under the Omnibus Plan.

G. International Considerations: For REITs that operate outside the U.S., special attention may be necessary to address:

• U.S. and foreign tax implications for non-U.S. participants;
• Local securities law requirements;
• Currency hedging considerations; and
• Cross-border transfer restrictions.

VII. Conclusion

LTIP Units (both FVLTIP Units and AOLTIP Units) represent sophisticated compensation tools that leverage the UPREIT structure to provide potentially favorable tax treatment for executives while aligning their interests with long-term value creation. The key differences between these instruments reflect their distinct economic structures: FVLTIP Units offer full value participation from the grant date forward (subject to book-up events), while AOLTIP Units offer option-like appreciation above a conversion threshold. AOLTIP Units generally have a 10% sharing percentage until conversion, then share on a net as-converted basis like other common units, compared to time-based FVLTIP Units which generally receive regular distributions and other non-liquidating distributions equal on a per unit basis to distributions paid to common unit holders. Performance-based FVLTIP Units also typically have a 10% sharing percentage in allocations and distributions prior to being earned with catch-up mechanisms to compensate the holder for dividends not paid during the performance measurement period.

The implementation of LTIP or AOLTIP unit programs requires careful consideration and REIT boards and compensation committees should work closely with experienced legal and tax advisors to ensure proper structuring and documentation. While LTIP Units offer significant tax advantages over traditional equity compensation awards, recipients should carefully evaluate the trade-offs between those benefits and increased complexity, including multi-state filing requirements, phantom income risks, and the uncertainty surrounding future legislative changes affecting carried interest treatment.

About Goodwin

Goodwin has been a leading advisor on UPREIT structures and related compensation arrangements since serving as special tax counsel in connection with the industry’s first public UPREIT structure in the Taubman Centers 1992 IPO. Goodwin created the first REIT LTIP Unit compensation program, implemented the first AOLTIP Units and has advised many UPREITs in creating and overseeing their LTIP programs in the years since.

This article is part of our “Unlocking the UPREIT Structure” series. For questions about this article or the implementation of LTIP Unit equity incentive programs, please contact your Goodwin attorney.

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1. ^[1] Under NYSE and Nasdaq rules, the wording of the plan can often be interpreted to contemplate LTIP Units even though a specific reference to partnership units is missing (e.g., the grants may fall within the definition of “Other Equity-Based Awards”). If no language in an Omnibus Plan can be construed to permit an LTIP Unit award type, an amendment to the plan may be needed, though it may be possible, depending on the circumstances, to do so without obtaining shareholder approval. ↩

2. ^[2] The methodologies for fair valuing FVLTIP Units and AOLTIP Units include special features and variables that may or may not apply to “standard” restricted stock, RSU or stock option awards, and the valuation process often requires specialized models that valuation consultants with expertise in the LTIP structure can bring to bear for the benefit of the REIT and executives alike. For example, LTIP Unit awards are typically valued at a discount to traditional equity awards, which may result in either (or both) lower disclosed grant amounts or an increased number of LTIP Units being granted to recipients. ↩

3. ^[3] Most REITs in an UPREIT structure either include LTIP Unit provisions in the partnership agreement at the time of their IPO or do so subsequently through amendments. Even if LTIP Units are contemplated by the partnership agreement, the specific features of FVLTIP Units and/or AOLTIP Units may require supplemental provisions dealing with allocations, distributions, conversions, exchanges and the like. It is important to confirm that necessary amendments to the partnership agreement, if any, can be adopted by the REIT as general partner without the consent of limited partners in the OP. ↩

4. ^[4] Legal and tax professionals should always be consulted in connection with the structuring of equity-based incentive programs, especially in the context of exchanging bonus for equity awards. ↩

5. ^[5] It may be possible in extraordinary cases to make compensatory awards of LTIP Units outside of a shareholder approved equity plan and outside of the context of an inducement grant, though such awards are subject to additional legal and disclosure considerations. ↩

6. ^[6] Like stock options, AOLTIP Units may generally be converted during a specified period (typically five to ten years). However, unlike FVLTIP Units that are almost always convertible one-for-one into common units, an AOLTIP Unit that is “in the money” always represents a fractional interest in a single common unit. Accordingly, while we refer to AOLTIP Units as “option-like” there is no corresponding ability to exercise an AOLTIP Unit award and acquire an equivalent number of shares of REIT common stock. ↩

7. ^[7] The holding period required to obtain long-term capital gain treatment for certain profits interests, commonly referred to as “carried interests,” is three years (compared to one year for other securities); capital gains allocated to carried interests from capital assets held by the operating partnership for three years or less are treated as short-term capital gain, taxed at ordinary income rates and ineligible for the 20% qualified business income deduction; capital gain on the sale or disposition of the carried interest itself is also treated as short-term capital gain if the service partner has not held the interest for more than three years. Technical issues concerning the determination whether specific awards of LTIP Units qualify as having been held for at least three years are discussed in Section VI, below. ↩

8. ^[8] This summary assumes that the non-qualified stock options are exempt from Section 409A of the Internal Revenue Code. ↩

9. ^[9] Except as otherwise noted, this article assumes that LTIP Units are respected as safe harbored profits interests for U.S. federal income tax purposes. Certain risks associated with achieving such treatment are beyond the scope of this article. ↩

10. ^[10] See IRS Revenue Procedures 93-27 and 2001-42. ↩

11. ^[11] Counterintuitively, though, while each LTIP Unit receives allocations as a single, distinct unit for purposes of its capital account, for most tax purposes the capital accounts of all partnership units held by a given partner (i.e., each FVLTIP Unit, each AOLTIP Unit and each common unit) are blended together. Each partner is treated as having a single, unitary interest in the OP without regard for the economic attributes of individual units that comprise that unitary interest, which in turn creates a potential issue in the context of capital gains rules applicable to so called “carried interests.” Specifically, while FVLTIP Units book-up individually on a unit-by-unit basis for purposes of becoming eligible to convert into common units, the holding period for each OP unit is a weighted average of the holding periods of all of the partnership units held by that partner. The result is that the exchange or redemption of an LTIP Unit that was issued more than three years ago may result in some short-term capital gain if the partner also holds other OP units that were acquired more recently. These concepts are discussed in more detail in Section VI, below. ↩

12. ^[12] Unless otherwise indicated, this article assumes the OP uses the REIT’s common stock price for this purpose. ↩

13. ^[13] Gain allocated to holders of LTIP Units as a result of book-up events is solely for capital account purposes, and therefore is not currently taxable to the holder. As discussed in Section VI below, there are circumstances where a holder is exposed to risk of so-called “phantom income” as a result of these book-up allocations, for example if the REIT engages in taxable sales of assets that generated the book gain allocated to LTIP Unit holders. ↩

14. ^[14] Alternatively some operative documents make FVLTIP Unit holders aware of the tax risk but do not restrict transfers within two years of grant. The scope of what constitutes a disposition for purposes of the two-year holding requirement in the Revenue Procedure (e.g. death, M&A transactions outside the holder’s control, etc.) is not clear. ↩

15. ^[15] The tax basis of LTIP Units is increased by any taxable income allocated to the holder and then reduced by the amount of cash or the value of other property distributed to the holder and by any taxable loss allocated to the holder. ↩

16. ^[16] Distribution provisions vary from OPP to OPP. In some cases, the catch-up distribution right is paid in additional FVLTIP Units that approximate as closely as possible the economic effect the recipient would have had if a number of shares of the REIT’s common stock equal to the number of FVLTIP Units that are ultimately earned had been issued on the original grant date and dividends payable on such units for each dividend payment date during the performance measurement period had been reinvested at a per share price equal to the trading price of a share of REIT common stock on each applicable ex-dividend date. Adjustments can also be made to account for any FVLTIP Units that have been forfeited, so that any “extra” dividends are offset by reducing the number of additional FVLTIP Units issued as a catch-up payment. ↩

17. ^[17] Many modern UPREIT partnership agreements provide that, so long as a corresponding unit split occurs, a stock split or reverse stock split will not impact the standard one-for-one conversion ratio between common units and shares of REIT stock. However, great care should be taken when evaluating the potential impact on LTIP Units and equity awards generally in the context of any contemplated stock split or similar corporate event. ↩

18. ^[18] A potential trap for the unwary is that, should the award documentation fail to provide for the correct adjustment mechanism under a particular set of circumstances, such that an amendment of the terms of the LTIP Units is required to avoid unfair outcomes for the recipients, the amendment may be characterized as a “material modification” for accounting purposes. While a discussion of GAAP consequences of a material modification is beyond the scope of this article, those consequences can be materially adverse to the REIT in terms of compensation expense recognition and other matters. The material modification risk is also present if the adjustment provisions of a LTIP Unit award are so open-ended as to amount to full discretion in the hands of the REIT’s compensation committee to deal with transactions without sufficient guidance in the award documentation. These issues require careful coordination between legal and accounting advisers. ↩

19. ^[19] Due to this structure, certain concepts that apply to stock options (such as the ability to exercise the option, even if underwater, and acquire an equivalent number of shares of stock) as well as certain special rules relating to, for example, qualification as “incentive stock options” do not apply to AOLTIP Units. However, from a disclosure perspective, AOLTIP Units are generally viewed as being equivalent to stock options, and therefore subject to the same reporting principles and requirements for purposes of the federal securities laws. ↩

20. ^[20] As is the case with so-called “premium” stock options, the threshold price can be set above the REIT’s stock price at the time of the award. ↩

21. ^[21] Note that, although we talk about valuation of AOLTIP Units and common units by reference to the trading price of one REIT share for simplicity here, the mechanics of the OP agreement instead depend on the value of the OP’s assets, which, in the ordinary course, are determined by reference to the value of REIT shares. ↩

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee similar outcomes.