REITs can provide a low capital entry point for those who want to get involved with real estate investing. They can provide dividends and potential capital appreciation. However, taxation is quite different between REITs and real property. Do REIT dividends offer any of the tax benefits that real property income provides, or is it all taxed as ordinary income?
On the surface, public REITs behave similarly to stocks. These REITs move up and down and can throw off dividends or income. The income components paid out by REITs can have different taxation.
When a REIT sells a property at a profit, it generates a capital gain. Short-term capital gains are taxed at your ordinary tax rate. Long-term capital gains rates are capped at 20%.
Some REIT dividends are qualified dividends. These dividends receive special tax treatment since they are taxed at long-term capital gains rates.
REITs may also return principal to investors. Because this is just a return on invested capital, it is not taxed.
Unfortunately, for many REITs, dividends are taxed at ordinary income tax rates. Taxation between private and public REITs is similar.
REIT income is considered pass-through income. REITs distribute around 90% of their income to shareholders. REITs aren’t taxed on the majority of their income. Instead, the shareholders are taxed, which is why the income is called pass-through. Not only does the income pass through to shareholders, but so does taxation.
How do you know if your REIT dividends are taxed at ordinary income tax rates, qualified dividends, capital gains, or a return of capital? Brokers or sponsors (for private REITs) send out 1099-DIVs to investors, which break down the different types of dividends an investor receives.
What does REIT taxation mean for retirement accounts? Because retirement accounts are not taxed, as many of them defer taxation until distributions are taken, any taxes on REIT dividends are deferred. REIT dividends can compound in these accounts tax-free, at least until distributions are taken.
This is different from a Roth IRA. Roth IRAs don’t pay taxes on distributions. Once a REIT is put into a Roth IRA, dividends can grow tax-free. Unlike a 401(k) or Traditional IRA, investors won’t owe taxes on these REIT dividends once distributions are taken.
Because REIT dividends are printed on a 1099-DIV, distinguishing the different types of REIT distributions is fairly simple. However, because taxes are unique to each individual and can get fairly complex, it’s best to work with a tax specialist when determining the taxation of REIT dividends.