Converting OP Units to Cash: Tax-Smart Timing

I keep seeing liquidity discussed as if it is simply a benefit. With OP units, it is a benefit only after a question is answered: how much of the deferred gain are you willing to recognize to get the cash?

Converting OP units to REIT shares and then selling them triggers deferred gain. That makes timing and pacing consequential. Converting everything in one year can produce a large tax bill, potentially at higher rates. Spreading conversions, using lower-income years, coordinating with losses, and holding units you do not need toward a step-up at death can change both the tax paid and when it is paid.

The goal: cash with minimal tax

The goal is plain: access the cash you need while minimizing the tax that conversion triggers. Turning OP units into cash by converting to REIT shares and selling triggers the deferred gain. That gain can include four layers of tax: capital gains, depreciation recapture, the Net Investment Income Tax, or NIIT, and state tax.

There is no way to make that trade disappear just by calling it liquidity. More conversion means more current cash and more current tax. Less conversion leaves more tax deferred but provides less cash. The useful question is how to meet a real liquidity need with the least unnecessary recognition of gain.

First-order thinking says, “I need cash, so I should convert.” Second-order thinking asks how much cash is actually needed, what other income and losses look like this year, whether the conversion will bunch gain into an unfavorable bracket, and whether some units are better left alone. That is the difference between reacting to a cash need and planning for after-tax cash.

Spreading conversions over years

The foundational approach is to convert portions over several years rather than all units at once. A full conversion recognizes the entire deferred gain in one year. That can create a large bill, push income into higher brackets, and bring NIIT and recapture into the same tax year all at once.

Pacing recognizes only a portion of the gain each year. It can keep more gain in lower brackets, may reduce or avoid NIIT in years when income remains below its thresholds, and generally lowers total tax across the conversion period. The practical effect is incremental cash access matched to incremental need.

That does not mean a slow conversion is automatically right. It means the timing should be deliberate. A conversion schedule should start with the cash requirement, then test the tax cost of meeting it in one year versus over several years.

Converting all units at once recognizes the whole gain in one year. Converting portions over several years can keep more gain in lower brackets and substantially reduce total tax.

Timing in low-income years

Pacing can be improved by looking at the investor’s income in each year. Capital-gains rates and NIIT depend on total income. In a lower-income year, conversion gain may be taxed at 0% or 15% rather than 20%, and NIIT may be avoided. In a higher-income year, the same conversion can cost more.

This matters especially for retirees and anyone with variable income. A period before Social Security or required distributions ramp up, or simply a low-earning year, can be an opportunity for a larger conversion. A high-income year may call for a smaller conversion or no conversion at all.

The purpose is not to predict every future tax result. It is to compare years before acting. Your CPA can identify favorable low-income years and test the rate effect of larger or smaller amounts.

Coordinating with other income and losses

Capital losses from other investments and carryforward losses can offset conversion gain. If those losses are available, converting in that year may reduce or eliminate tax on the converted amount.

The same logic applies to the wider tax picture. Deductions, credits, and a low-income period can reduce net tax. A conversion should be considered alongside all of those factors rather than in isolation.

Your CPA is central here. They can model the conversion gain, identify available losses, account for deductions and other income, and show which timing choices minimize the tax. The conversion is a tax-planning exercise; it is not a generic rule to convert a fixed percentage every year.

The step-up alternative

The most tax-efficient conversion can be the one you do not make. Units not needed for cash can be held toward a step-up at death. Under the source material’s framework, that step-up erases the deferred gain on those units rather than triggering it. They may continue earning distributions while they are held.

That makes the amount decision as important as the timing decision. Convert what you need, in a tax-aware way. Hold what you do not need if the step-up alternative fits the investor’s circumstances and planning. The two approaches can work together: liquidity from a measured conversion, and ongoing deferral for the remaining core.

Key takeaways

• Converting OP units to cash triggers deferred gain, so the objective is needed liquidity with minimal tax.
• Spreading conversions across years is the foundational way to avoid bunching gain into one tax year.
• Lower-income-year timing and loss coordination can reduce the tax rate or offset gain.
• Units not needed for cash can be held toward a step-up at death, so conversion can be limited to what is needed.

A conversion schedule approach

A conversion schedule turns these ideas into a practical plan. Rather than converting reactively or all at once, you and your CPA decide how much to convert each year based on cash needs and the tax circumstances of that year. The plan can spread gain, favor lower-income years, and use available losses.

One schedule might convert a set portion each year to provide steady cash while spreading tax. Another might convert more in lower-income years and less in higher-income years, while retaining a core of units toward a step-up. The correct amount depends on when cash is needed, other income, losses, and applicable brackets.

The schedule should be reviewed annually. Income, cash needs, K-1 allocations, distributions, and tax facts change. An adjustable schedule is more useful than a rigid rule because it keeps the plan tied to actual circumstances.

How Baker 1031 helps with conversion timing

Baker 1031 Investments helps OP-unit holders plan tax-smart conversions to cash in coordination with their CPA. That can include spreading conversions over years, identifying favorable low-income years, coordinating with losses, holding units not needed for cash toward a step-up, and building a conversion schedule.

REIT units and related securities are offered through the broker-dealer, Aurora Securities, Inc. (member FINRA/SIPC), and any recommendation follows a suitability review. Baker 1031 does not provide tax advice; the CPA models the conversion tax and advises on timing. The role is to help plan and execute a conversion strategy alongside that CPA work.

Frequently Asked Questions

Why does the timing of converting OP units matter?

Converting OP units to cash through REIT shares triggers deferred gain, so timing and pacing affect both the amount of tax and when it is due. A full conversion can recognize the entire gain in one year and potentially at higher rates. Spreading conversions, using favorable years, coordinating losses, and holding unneeded units toward a step-up can substantially smooth or reduce the tax.

How does spreading conversions reduce tax?

Pacing recognizes only part of the gain each year instead of all of it at once. It can keep more gain in lower brackets, may reduce or avoid NIIT in some years if income remains below thresholds, and generally lowers total tax over the conversion period. It is the foundational way to access cash incrementally while managing gain recognition.

Should I convert in low-income years?

When possible, a lower-income year can be favorable because conversion gain may face a 0% or 15% capital-gains rate instead of 20% and may avoid NIIT. A retiree or someone with variable income may convert more in a lower-income year and less, or none, in a high-income year. A CPA can identify the favorable years.

Can I use losses to offset conversion gains?

Yes. Capital losses and carryforward losses may offset conversion gain when conversion is timed to a year in which those losses are available. Deductions and lower-income periods can also reduce net tax. Your CPA can coordinate the conversion with these factors.

What if I do not need to convert all my units?

Hold the units you do not need toward a step-up at death. The source material describes that step-up as erasing deferred gain on the held units. Those units can continue earning distributions without conversion tax being triggered. Convert the amount needed for cash and hold the rest when that plan fits your circumstances.

What is a conversion schedule?

It is a planned, adjustable approach to converting units over time. You and your CPA set annual amounts around cash needs and tax circumstances, spread the gain, favor low-income years where appropriate, coordinate with losses, and may retain a core toward a step-up. The schedule should be reviewed annually.

How much should I convert each year?

There is no fixed amount. The amount depends on cash needs and tax circumstances. The general aim is to meet the cash need while avoiding unnecessary bunching, a 20% capital-gains rate, or NIIT where possible. A CPA can model annual amounts and rates.

Does converting trigger depreciation recapture too?

Yes. Conversion triggers deferred gain, including depreciation recapture associated with the originally contributed property. Recapture can be taxed at rates up to 25%. Pacing spreads that recognition, and holding units toward a step-up avoids conversion on the units that are not converted. Your CPA should include recapture in the conversion-tax model.

Is it better to convert gradually or hold for the step-up?

It depends on cash needs. If cash is needed, gradual tax-smart conversion can provide it while managing tax. If cash is not needed, holding units toward a step-up can be more tax-efficient. Many investors may combine the two, converting what they need and holding what they do not.

Can my CPA help plan my conversions?

Yes. The CPA can model conversion tax, identify favorable low-income years, coordinate capital losses and other tax factors, determine annual conversion amounts, and help create and adjust the schedule. Baker 1031 coordinates on the strategy; the CPA leads tax advice and modeling.

How does Baker 1031 help with conversion timing?

Baker 1031 helps plan the pacing, favorable-year timing, loss coordination, step-up alternative, and a conversion schedule with the CPA. REIT units are offered through Aurora Securities, member FINRA/SIPC, after a suitability review. Baker 1031 does not give tax advice; the CPA models tax and advises on timing.

Does converting in retirement affect my Social Security or Medicare?

It can. Recognized capital gain increases reported income and can affect income-based thresholds, including taxation of Social Security benefits and Medicare premium surcharges, or IRMAA, which are based on modified adjusted gross income. That is another reason to plan with a CPA rather than look only at the capital-gains rate.

Can I convert OP units gradually for retirement income?

Yes. A planned gradual conversion can provide retirement cash flow in addition to distributions. Converting a portion each year can spread gain recognition across retirement years. The annual amount should be planned with the CPA for both the income needed and tax efficiency.

What records do I need for converting OP units?

Keep records of unit basis, which carries over from the contributed property and changes over time with K-1 income allocations and distributions or return of capital. Also retain conversion details: units converted, dates, values, and gain calculations. Your CPA uses those records to calculate and report conversion tax, but you should maintain your own records as well.

Glossary

• Tax-Smart Conversion: Converting OP units to cash while minimizing tax.
• Conversion: Exchanging units for shares and then cash, which triggers gain.
• Deferred Gain: The gain triggered when units are converted—the conversion tax.
• Spreading Conversions: Converting portions over years to smooth gain recognition.
• Low-Income Year: A lower-income year that can be favorable for conversion.
• Capital Gains Brackets: The 0%, 15%, and 20% rate tiers that timing seeks to optimize.
• Net Investment Income Tax: The 3.8% tax that timing can sometimes avoid.
• Loss Coordination: Timing conversions to use capital losses against gain.
• Step-Up Alternative: Holding units not needed for cash toward a step-up to avoid tax on those units.
• Conversion Schedule: A planned conversion over time to optimize tax.
• Depreciation Recapture: A conversion-triggered gain component that can be taxed up to 25%.
• Bunching: Triggering all gain in one year, which pacing seeks to avoid.
• Liquidity Needs: The cash required, which drives conversion amount and timing.
• Carryforward Loss: A loss available to offset conversion gain.
• Annual Review: Adjusting the schedule as circumstances change.
• After-Tax Cash: The net cash after conversion tax, improved by tax-smart timing.

Sources & References

1. IRS. Topic No. 409, Capital Gains and Losses
2. IRS. Topic No. 559, Net Investment Income Tax
3. Cornell Legal Information Institute. 26 U.S. Code § 1014 — Basis of property acquired from a decedent
4. Cornell Legal Information Institute. 26 U.S. Code § 721 — Nonrecognition of gain or loss on contribution

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.

Filed under

721 Exchange · 721 UPREIT · REITs

About the author

Jerry Baker
Founder & Managing Principal, Baker 1031 Investments · FINRA Series 22 / 63 · SIE

Jerry founded Baker 1031 to bring institutional underwriting discipline to the 1031 exchange. He spent more than a decade on Wall Street working on $10B+ of real estate before building diversified DST portfolios for individual investors. Read full bio →

Reviewed by: Lori Kamen — President & CCO, Aurora Securities, Inc. (FINRA Series 4 / 7 / 24 / 53 / 63 / 66), the supervising registered principal. Last reviewed June 2026. Baker 1031 reviews its educational content periodically for accuracy and regulatory compliance. Securities offered through Aurora Securities, member FINRA/SIPC.

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I would manage this by treating an OP-unit conversion as a capital-allocation decision, not merely a way to access liquidity. I would set the cash need, ask the CPA to model the tax and income-threshold effects, convert only the amount needed, and revisit the plan every year. Which trade-off matters more to you right now: immediate cash, a smoother tax bill, or keeping more units toward a step-up? Share your view in the comments.