A Real Estate Investment Trust, or REIT, is an organization that owns, operates, or finances real estate assets with the intention of earning income for the investors (shareholders). Because REITs use funds from a group of investors, minor participants may have access to investments they would not otherwise. For example, a REIT may own multi-family housing or other commercial real estate sectors like office buildings, retail, industrial, and healthcare.
A REIT May Be Traded Publicly or Not at All
Most REITs are traded and subject to the oversight of the Securities and Exchange Commission. These investments are considered liquid since market forces determine the value, and an investor can buy and sell quickly. As with other publicly traded assets, any investor can participate.
Non-traded REITs are not bought and sold on a public exchange, although in other ways, they are similar to publicly-traded REITs. They are more challenging to assign a value to, should be considered illiquid, and usually have a minimum holding period.
What Defines a REIT?
To meet the definition of a REIT, a company must follow specific rules in its structure and activities, including these:
- At least 75% of the trust assets must be used to invest in real estate or related assets. Some REITs buy property while others focus on financial instruments such as mortgages.
- A minimum of 75% of the company's gross income must stem from real estate activities, and no less than 90% of taxable income needs to be disbursed to investors.
- A REIT needs a minimum of 100 shareholders, and the concentration must be spread out so that less than 50% is owned by any five individual investors.
REIT Distributions Are Taxable to the Shareholder
Suppose a REIT follows the dictates noted above so that it qualifies. In that case, the income it distributes to the participants in the form of dividends can be deducted from their taxable income. In contrast, the shareholders pay taxes on the dividends at their ordinary income rate. This status may be different from the income the investor receives from other corporate dividends. For that reason, investors may want to hold REIT shares in a retirement account like an IRA (Individual Retirement Account).
IRA Gains Are Tax-Deferred
When a taxpayer contributes to an IRA (if eligible to do so), they can generally deduct the funds set aside from their current year income. This benefit is intended to encourage taxpayers to save for their retirement. In addition, investment gains are not subject to tax while the money remains in the account. However, when distributions are eventually made from the account (whether from contributions or profits), it is taxable income to the investor. The assumption is that the taxpayer will have a lower rate in retirement than they did during their working years.
A Roth IRA May Offer Additional Benefits
Since a Roth IRA, which is a type of retirement account within the individual retirement account category, does not offer a tax deduction for the investor's contribution, the withdrawals taken in retirement are not taxed. Therefore, the potential benefit of having REIT investments in the Roth IRA is that the dividends you may earn will also not be taxed when withdrawn.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. All investments have an inherent level of risk. The value of your investment will fluctuate with the value of the underlying investments. You could receive back less than you initially invested and there is no guarantee that you will receive any income. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate. There are risks associated with these types of investments and include but are not limited to the following: Typically no secondary market exists for the security listed above. Potential difficulty discerning between routine interest payments and principal repayment. Redemption price of a REIT may be worth more or less than the original price paid. Value of the shares in the trust will fluctuate with the portfolio of underlying real estate. Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes. This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein. The offering is made only by the Prospectus. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
