REIT dividends can have a mixture of taxation. This all depends on the specific REIT. Because of these differences, understanding the taxation of REIT dividends can be somewhat complex. In this article, we’ll discuss how REIT dividends might be taxed.
Most REITs do not pay income taxes if they distribute at least 90% of their income to shareholders. REITs distribute their income to shareholders in a variety of ways.
Income from rent is classified as ordinary income. A gain on the sale of property is a capital gain. Sometimes the REIT returns capital to shareholders. This is a non-taxable event since shareholders are getting their principal back.
Some REITs pay out qualified dividends, taxed at the long-term capital gains rate. A qualified dividend must meet three primary criteria:
In summary, the holding period test is that you must hold common stock for 61 days within a 121-day period. For full details and rules of the holding period test, please check this link https://www.irs.gov/pub/irs-news/ir-04-022.pdf.
Qualified dividends have a maximum tax rate of 20% but can go up to 23.8% if an investor is subject to net investment income tax (NIIT), which usually applies to high earners. Qualified dividends can also come from companies such as MSFT, AAPL, and JNJ.
As an example of how a qualified dividend is taxed:
An investor earns $1000 in dividends from a REIT. At a 15% qualified dividend tax rate, the investor will pay $150 in taxes.
Capital gains distributions do not qualify as a qualified dividend. Dividends paid from a bank, credit union, or savings loan account also do not qualify as qualified dividends. This list is by no means exhaustive.
Some REIT dividends are a combination of qualified and non-qualified dividends. For many REITs, most of their dividends are considered non-qualified.
REITs are considered mostly pass-through income, taxed at an investor’s ordinary income tax rate. In some cases, all dividends of a REIT may be classified as ordinary income.
Investors can find the breakdown of their dividends on a 1099-DIV. The 1099-DIV summarizes investor activity for a specific brokerage account. Investors will get a 1099-DIV for each taxable brokerage account that they have. Note that retirement accounts will not receive a 1099-DIV as they are not taxable accounts. The 1099-DIV generally arrives around February of the following year (e.g., the year taxes are due).
Because of the tax reform bill (2017 Tax Cuts and Jobs Act), REIT income is considered small business income or qualified business income (QBI). QBI is part of the Section 199 deduction. The following is an example of the QBI tax calculation:
An investor’s tax rate is 22%. They receive $1000 in dividends that are a Section 199 deduction. Taxes owed will be 20% x $1000 = $800 x 22% = $176. This is a little more than the 15% long-term capital gains rate.
REIT dividend taxation can be complex because of the different ways that dividends can be taxed. Therefore, it’s best to work with a tax specialist when calculating taxes due on REIT dividends.