A Guide for Investment Property Owners Considering REITs
For investment property owners looking to generate income without the day-to-day management responsibilities, Real Estate Investment Trusts (REITs) can be a compelling alternative. However, understanding how REIT income is taxed is a key factor in making informed decisions—especially for those transitioning from direct ownership, 1031 Exchanges, or other tax-advantaged strategies.
Here’s a breakdown of how REIT income is taxed, what to expect, and how to potentially enhance your after-tax outcomes.
A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate. Investors purchase shares in the REIT and, in return, receive a portion of the income generated by the underlying properties—typically in the form of dividends.
Publicly traded REITs are listed on major stock exchanges, while non-traded and private REITs are less liquid but may offer different income and risk profiles.
REIT income is primarily distributed as dividends and is generally taxed in one of three ways:
Most REIT dividends are taxed as ordinary income, at your marginal federal income tax rate (up to 37% as of 2025). Unlike qualified dividends from many stocks, most REIT dividends do not qualify for the lower long-term capital gains tax rates. However, a 20% Qualified Business Income (QBI) deduction may apply through 2025 for eligible taxpayers.
Some REIT distributions are classified as a return of capital. This portion isn’t immediately taxable but instead reduces your cost basis in the REIT shares. When you sell those shares, the deferred gain is taxed as a capital gain.
If the REIT sells assets and passes the gains to shareholders, that portion is typically taxed at long-term capital gains rates (0%, 15%, or 20%, depending on your income).
Note: Some or all of your REIT revenue may also be subject to the 3.8% Net Investment Income Tax (NIIT) if your modified adjusted gross income exceeds applicable thresholds.
Thanks to the Tax Cuts and Jobs Act, individual investors may be eligible for a 20% deduction on qualified REIT dividends through the Section 199A Qualified Business Income (QBI) deduction. This reduces the effective tax rate on some REIT income.
However, limitations and eligibility requirements apply—consult a tax professional to determine how this applies to your situation.
REITs may appear less tax-efficient for investors accustomed to deferring taxes via 1031 Exchanges. A 1031 Exchange into a Delaware Statutory Trust (DST) enables continued deferral of capital gains, depreciation recapture, and can support estate planning benefits like step-up in basis.
However, these benefits come with important considerations. DSTs are illiquid, typically require accredited investor status, and often involve multi-year holding periods with limited control over asset decisions. Additionally, failure to adhere to IRS rules—such as acquiring like-kind property of equal or greater value—can trigger immediate tax consequences.
In contrast, Real Estate Investment Trusts (REITs) provide liquidity, accessibility through public markets, and regular income distributions. Yet, most REIT dividends are taxable in the year received, usually at ordinary income tax rates, which may result in a higher current tax liability than deferred alternatives. REIT investments generally don’t qualify for 1031 treatment, unless accessed through a specialized UPREIT structure. UPREIT strategies, while enabling tax deferral, involve additional complexity, potential holding requirements, and reduced flexibility in managing timing or exit strategies.
Understanding how REIT dividends are taxed can help real estate investors compare options based on their goals and circumstances. Realized can provide educational resources on both REITs and DSTs to support informed decision-making with the help of your tax and financial advisors.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Article written by: Story Amplify. Story Amplify is a marketing agency that offers services such as copywriting across industries, including financial services, real estate investment services, and miscellaneous small businesses.