REITs are already tax-advantaged investments because their profits are shielded from corporate income taxes. Because REITs are considered pass-through corporations, they must disperse the majority of their profits to shareholders.
The majority of your REIT dividends will be classified as regular income if you hold them in a conventional (taxable) brokerage account. However, it’s likely that some of your REIT dividends will fall under the IRS’s definition of qualified dividends, and that some of them would be treated as a non-taxable return of capital.
Ordinary income REIT dividends meet the requirements for the new Qualified Business Income deduction. This permits you to deduct up to 20% of your REIT payouts from your taxable income.
Holding REITs in tax-advantaged retirement accounts, such as regular or Roth IRAs, SIMPLE IRAs, SEP-IRAs, or other tax-deferred or after-tax retirement accounts, is the greatest option to avoid paying taxes on them.
You can save hundreds or thousands of dollars on your investment taxes if you follow these guidelines.
Do REITs have tax advantages?
Understanding the tax implications of investing in a Real Estate Investment Trust (REIT) is one of the most important factors when adding commercial real estate investments to a well-balanced portfolio approach “When analyzing various options, REITs may be beneficial. Currently, Jamestown is offering Jamestown Invest 1, LLC (the) (the) (the) (the) (the) (the) (the) (the) “Fund”), which is available to accredited and non-accredited investors in the United States. The Fund is established as a REIT with the goal of acquiring and managing a portfolio of real estate investments in urban infill regions that are expected to grow. By the end of this article, you should be able to spot potential REIT tax benefits and better interpret your 1099-DIV form, as well as understand a few IRS rules relevant to REIT investments.
What is a REIT?
The United States Congress first introduced REITs in 1960. Until then, institutional investors were the only ones who could invest in commercial real estate. Most people lacked the financial means or resources to make important and diverse investments in the space. The REIT structure was designed by Congress to address this imbalance. Individual investors were able to pool assets and make major investments in commercial real estate by investing in a REIT.
You may have also heard that REITs are a time-consuming vehicle to manage, and this is correct! It is not, however, without justification. Congress has set various restrictions on the structure and operation of REITs in order to ensure that they meet their legislative goals. The REIT must maintain certain levels of investment in real estate assets and earn particular levels of income from real estate and other passive vehicles in order to be considered a passive real estate investor. There are special shareholder criteria and constraints on the concentration of ownership of REIT shares to ensure that money are pooled by individual investors. REITs that meet these criteria receive preferential tax treatment (discussed in more detail below).
How Are Realized Returns Determined?
Before going into some of the tax advantages of investing in a REIT fund, it’s crucial to understand how commercial real estate trusts create profits for investors. Operating distributions and capital gain distributions are the two components of real estate realized returns.
- Investors receive operating distributions (usually monthly or quarterly) from the cash flow generated by the fund’s underlying real estate investments. This is usually achieved by net rental income or portfolio income from the REIT, such as interest and dividends.
- The capital gain from the sale of real estate within the REIT is the second component of realized returns potential.
How Are Realized Returns Categorized?
A REIT must transfer the bulk of its taxable income to its shareholders in order to maintain its beneficial tax status. REIT distributions are classified into one of the following types. There is a different tax treatment for each category.
- Capital Gains – depending on whether the investment or its underlying property is held for less than or more than 12 months, capital gains are taxed at a short-term or long-term capital gain rate.
If you recall from our post on How to Invest in Real Estate with a Self-Directed IRA, if you own a REIT in a tax-deferred account like a regular IRA, you only pay taxes on the money when you remove it.
What Are the Potential Tax Benefits of Investing in a REIT?
REITs are eligible for special tax treatment if they meet the IRS’s standards. Eligible REIT structures, unlike other U.S. corporations, are not subject to double taxation. Dividends provided to shareholders help REITs avoid paying corporate income tax. Shareholders may then benefit from preferential US tax rates on REIT dividend distributions.
The Tax Cuts and Jobs Act (TCJA), which was signed into law in 2017, made REIT investing even more tax-efficient. Many taxpayers are eligible for a tax deduction of up to 20% for Qualified Business Income under the TCJA, subject to specified income criteria. Ordinary REIT dividends, interestingly, qualify as Business Income for this reason, and REIT dividends aren’t subject to the income thresholds, thus REIT investors can take advantage of this provision regardless of their income!
The qualified business income deduction is equal to the lesser of (1) 20% of combined qualified business income or (2) 20% of taxable income minus the taxpayer’s net capital gain amount (if any).
The hypothetical after-tax return shown below is based on a $10,000 investment with a 7% yearly dividend yield. We’ll assume a single tax filer who has no capital gains and is in the highest federal marginal tax rate of 37 percent in 2020.
Will I Receive a Schedule K-1 or Form 1099-DIV?
Investors frequently inquire about whether they will receive a 1099 or a K-1 at the start of the year. While a Sponsor’s Investor Relations or Tax Team can provide this information, there are some general standards to be aware of before investing.
A REIT, brokerage, bank, mutual fund, or real estate fund issues Form 1099-DIV to the Internal Revenue Service. Persons who have received dividends or other distributions of $10 or more in money or other property will get Form 1099-DIV. Dividend income is taxed in the state(s) where the person resides, regardless of the location of the property.
Schedule K-1 is an annual tax form issued by the Internal Revenue Service for a partnership investment. Schedule K-1 is used to report each partner’s portion of the partnership’s profit, loss, deductions, and credits. Real estate partnership income may be taxed in the state(s) where the property is located. A Schedule K-1 is identical to a Form 1099 in terms of tax reporting.
Understanding your IRS Form 1099-DIV
If you invest directly in a REIT, you will receive a 1099-DIV from the REIT. You’ll find that numerous boxes on your Form 1099-DIV have already been filled in. Some of the reporting boxes and their ramifications were recently detailed in an article released by TurboTax, a market leader in tax software for preparing US tax returns.
- The percentage of box 1a that is considered qualified dividends is reported in box 1b.
- If you get a capital gain distribution from your investment, you must record it in box 2a.
- If any state or federal taxes were withheld from your dividends, report them in boxes 4 and 14 for federal withholding and state withholding, respectively.
REITs that comply with the law are exempt from paying corporate taxes. Ordinary and capital gain dividend income are taxed at the REIT shareholders’ respective tax rates. Ordinary dividends paid by REITs can be deducted up to 20% before income tax is calculated.
Built-in diversification without the hassle of several state income tax forms is an advantage of investing in a fund with exposure to multiple properties. In comparison to investing in numerous individual properties via partnerships, investors will only pay state taxes on their dividends and capital gains in their individual state(s) of residence.
While many people are aware with publicly traded REITs that offer the tax benefits we’ve discussed, combining some of these benefits with non-correlative private real estate may be a viable option for investors looking for a more diversified portfolio. Alternative investments have been a part of many high-net-worth individuals’ and institutions’ portfolios for decades, but they are still not a portfolio staple for many people.
Can I get a tax break from a REIT?
In reality, REITs are perfect candidates for IRAs and other retirement accounts due to the IRS’s tax treatment of them. For starters, because REITs are considered pass-through assets, their dividends are normally treated as regular income (rather than qualified dividends) and are thus taxable at your marginal tax rate (tax bracket). There is no dividend tax due at the end of the year in retirement accounts, and no capital gains tax is owed on investor profits from the sale of any investment. In a regular IRA, you won’t pay any taxes until you withdraw, whereas eligible withdrawals in a Roth IRA are completely tax-free.
This is a one-of-a-kind double tax benefit for retirees. Not only does REIT income avoid corporation taxes, but REIT dividends can also be tax-free provided you hold your publicly listed REIT investments in the correct account type. Because you can reinvest your whole distribution, not just what’s left over after taxes, this can help your REIT dividends compound considerably faster over time.
How are REITs taxed differently?
Dividend payments are assigned to ordinary income, capital gains, and return of capital for tax reasons for REITs, each of which may be taxed at a different rate. Early in the year, all public firms, including REITs, must furnish shareholders with information indicating how the prior year’s dividends should be allocated for tax purposes. The Industry Data section contains a historical record of the allocation of REIT distributions between regular income, return of capital, and capital gains.
The majority of REIT dividends are taxed as ordinary income up to a maximum rate of 37% (returning to 39.6% in 2026), plus a 3.8 percent surtax on investment income. Through December 31, 2025, taxpayers can deduct 20% of their combined qualifying business income, which includes Qualified REIT Dividends. When the 20% deduction is taken into account, the highest effective tax rate on Qualified REIT Dividends is normally 29.6%.
REIT dividends, on the other hand, will be taxed at a lower rate in the following situations:
- When a REIT makes a capital gains distribution (tax rate of up to 20% plus a 3.8 percent surtax) or a return of capital dividend (tax rate of up to 20% plus a 3.8 percent surtax);
- When a REIT distributes dividends received from a taxable REIT subsidiary or other corporation (20% maximum tax rate plus 3.8 percent surtax); and when a REIT distributes dividends received from a taxable REIT subsidiary or other corporation (20% maximum tax rate plus 3.8 percent surtax); and when a REIT distributes dividends received from
- When allowed, a REIT pays corporation taxes and keeps the profits (20 percent maximum tax rate, plus the 3.8 percent surtax).
Furthermore, the maximum capital gains rate of 20% (plus the 3.8 percent surtax) applies to the sale of REIT stock in general.
The withholding tax rate on REIT ordinary dividends paid to non-US investors is depicted in this graph.
Why REITs are a bad idea?
Because no investment is flawless, you should be aware of the possible negatives of REITs before incorporating them into your portfolio.
- Dividend taxation: REITs pay out higher-than-average dividends and aren’t subject to corporate taxation. The disadvantage is that REIT payouts don’t always qualify as “qualified dividends,” which are taxed at a lower rate than ordinary income.
- Interest rate sensitivity: Because rising interest rates are detrimental for REIT stock values, REITs can be extremely sensitive to interest rate movements. When the rates on risk-free investments like Treasury securities rise, the returns on other income-based investments rise as well. The yield on the 10-year Treasury is an excellent REIT indication.
- Real estate investment trusts (REITs) can help diversify your portfolio, but most REITs aren’t highly diversified. They tend to concentrate on a single property type, each with its own set of dangers. Hotel REITs, for example, are extremely vulnerable to economic downturns and other factors. If you decide to invest in REITs, it’s a good idea to pick a few with varying degrees of economic sensitivity.
- Fees and markups: While REITs provide liquidity, trading in and out of them comes at a significant price. The majority of a REIT’s fees are paid up front. They can account for 20% to 30% of the REIT’s total worth. This consumes a significant portion of your prospective profit.
Weak Growth
REITs that are publicly listed are required to pay out 90% of their profits in dividends to shareholders right away. This leaves little money to expand the portfolio by purchasing additional properties, which is what drives appreciation.
Private REITs are a good option if you enjoy the idea of REITs but want to get more than just dividends.
No Control Over Returns or Performance
Investors in direct real estate have a lot of control over their profits. They can identify properties with high cash flow, actively promote vacant rentals to renters, properly screen all applications, and use other property management best practices.
Investors in REITs, on the other hand, can only sell their shares if they are unhappy with the company’s performance. Some private REITs won’t even be able to do that, at least for the first several years.
Yield Taxed as Regular Income
Dividends are taxed at the (higher) regular income tax rate, despite the fact that profits on investments held longer than a year are taxed at the lower capital gains tax rate.
And because REITs provide a large portion of their returns in the form of dividends, investors may face a greater tax bill than they would with more appreciation-oriented assets.
Potential for High Risk and Fees
Just because an investment is regulated by the SEC does not mean it is low-risk. Before investing, do your homework and think about all aspects of the real estate market, including property valuations, interest rates, debt, geography, and changing tax regulations.
Fees should also be factored into the due diligence process. High management and transaction fees are charged by some REITs, resulting in smaller returns to shareholders. Those fees are frequently buried in the fine print of investment offerings, so be prepared to dig through the fine print to find out what they pay themselves for property management, acquisition fees, and so on.
Why do REITs not pay taxes?
A REIT is required by law to deliver at least 90% of its taxable revenue in the form of dividends to its owners each year. This allows REITs to transfer their tax burden on to their shareholders rather than paying federal taxes.
Do REITs pass-through losses?
Finally, a real estate investment trust (REIT) is not a pass-through corporation. This means that, unlike a partnership, a REIT is unable to pass on any tax losses to its shareholders.
Are REITs taxed twice?
REITs are considered as pass-through corporations for tax purposes because of this last condition. Pass-through entities include LLCs and partnerships. Consider owning a convenience store with two business partners. You will receive a proportional share of the business’s income, which you will declare as income on your individual tax return.
A REIT’s profits are not taxed at the corporate level because it is a pass-through entity. It doesn’t matter how much money the REIT makes; as long as it meets the REIT rules, it won’t have to pay any corporate taxes.
This is a significant advantage for REIT investors. Profits from the majority of dividend-paying equities are effectively taxed twice. First, the business pays corporation taxes on its profits (currently taxed at a 21 percent rate). When gains are handed out as dividends, shareholders are taxed again.
To be fair, REITs aren’t entirely free of taxes. For one thing, they continue to pay property taxes on their real estate assets. REITs may also be required to pay income taxes in certain circumstances.
Are REIT dividends taxable if reinvested?
The tax rules that govern REITs encourage the distribution of earnings to shareholders in the form of dividends. The same requirements apply to dividends, which means that even if they are reinvested in more REIT shares, investors must pay taxes on them.
What is one of the disadvantages of investing in a private REIT?
With all of the benefits in mind, it’s vital to note that there are a few significant drawbacks to investing in private REITs. Before you consider investing in a private REIT, you should be aware of the following potential drawbacks:
Transparency is lacking — Because private REITs are not subject to the same regulatory scrutiny as public REITs (in fact, they are excluded from SEC registration), managers have a lot of leeway to make decisions that aren’t always in the best interests of shareholders. Conflicts of interest, for example, do not have to be declared by private REIT sponsors. Furthermore, trustworthy performance statistics for private REITs as a whole can be difficult to come by. To be quite honest, this is the primary reason I don’t own any private REITs in my personal portfolio.
Only accredited investors are eligible to participate — Private REITs are only available to authorized investors due to greater risks, the potential for investor abuse, and the lack of a liquid market. This usually means they’re only available to institutional investors or individuals with at least $1 million in assets or $200,000 in annual income.
Lack of liquidity — It can be tough to cash out a private REIT once you’ve invested. Private REITs do not allow you to sell shares immediately when the market is open, as it does with publicly traded REITs. When it comes to stock redemption, each corporation has its own set of rules, which can be quite stringent.
High commissions (in most cases) — Because brokers sell private REITs to clients, a significant amount of your private REIT investment may go into commissions. In fact, private REITs have been reported to spend up to 12% in marketing costs and commissions. This means that if you put $10,000 into a private REIT, only $8,800 of it could be invested. That’s insane.
To be honest, not all private REIT commission arrangements are unfair, but it’s critical to be informed of the fees and commissions you’re paying. After all, other from the tiny trading commission required by your brokerage, publicly traded REITs have no commissions.
High minimum investments — Minimum investments in private REITs often range from $1,000 to $25,000, depending on the company (or more in some cases). A publicly quoted REIT, on the other hand, can be purchased for as little as one share, and many public non-listed REITs have similarly low minimums.
Why do REITs pay high dividends?
REITs are a significant investment for both retirement savings and retirees who want a steady income stream to fund their living expenditures because of the high dividend income they generate. Because REITs are obligated to transfer at least 90% of their taxable profits to their shareholders each year, their dividends are large. Their dividends are supported by a consistent stream of contractual rents paid by their tenants. REITs are also an useful portfolio diversifier due to the low correlation of listed REIT stock returns with the returns of other equities and fixed-income investments. REIT returns tend to “zig” while other investments “zag,” lowering overall volatility and improving returns for a given amount of risk in a portfolio.
- Long-Term Performance: REITs have delivered long-term total returns that are comparable to those of other stocks.
- Significant, Stable Dividend Yields: REIT dividend yields have historically provided a consistent stream of income regardless of market conditions.
- Shares of publicly traded REITs are readily available for trading on the major stock exchanges.
- Transparency: The performance and prognosis of listed REITs are monitored by independent directors, analysts, and auditors, as well as the business and financial media. This oversight offers investors with a level of security as well as multiple indicators of a REIT’s financial health.
- REITs provide access to the real estate market with low connection to other stocks and bonds, allowing for portfolio diversification.
