In order to qualify as a real estate investment trust, the trust has to return a minimum of 90 percent of taxable income gained from income-producing properties, asset divestiture, and other means back to shareholders in the form of annual dividends.
In most cases, those dividends are taxed as regular income and are subject to an investor’s marginal tax rate, which could be as much as 37 percent for taxpayers reporting taxable income greater than $523,600 for single filers and $628,300 for married couples who file a joint return in 2021.¹
However, REIT dividends are typically made up of three income streams, and that income is taxed in different ways. In this article we’ll provide a rundown of how REIT income is taxed to provide investors with a clearer understanding of REIT taxation methods.
REIT Income Demystified
Qualified REITs are exempted from paying corporate income taxes because the bulk of their income is returned to shareholders. Individual shareholders shoulder that burden instead.
REIT investors receive a Form 1099-DIV each tax season, with stated dividend income broken down into three categories:²
- Ordinary dividends. This income will comprise the bulk of annual dividend payments and is taxed at your marginal tax rate. Since the majority of dividend payments from REITs are generated from their income-producing real estate assets, these payments are treated as ordinary income by the IRS.
- Capital gains. Dividends classified as capital gains are generated when a REIT divests real property at a profit. Capital gains are taxed up to 20 percent depending on your gross annual income and filing status. They are considered long-term gains since REITs generally hold properties in their portfolios for at least one year.³
- Nontaxable return of capital. Return of capital dividend payments occur when cash distributions are greater than a REITs earnings. These dividends aren’t taxed; rather, they reduce your cost basis in the investment. Taxes are deferred until you sell your shares of the REIT and are either long- or short-term depending on how long you held your shares.
Furthermore, under the Tax Cuts and Jobs Act of 2017, REIT dividends may be eligible for a 20-percent pass-through deduction. Trusts, estates, and individual taxpayers holding REIT shares after 2017 and before the year 2026 are eligible for this tax break.
The Bottom Line
REITs that return 90 percent or more of income back to shareholders as dividend payments don’t pay corporate income taxes -- that burden is borne by individual REIT investors. REIT dividend payments are broken down into three categories, but most of your annual payments will be taxed as ordinary income. Some REIT dividends could receive additional preferential tax treatment under the Tax Cuts and Jobs Act.
This primer is intended to give investors cursory knowledge of REIT taxation methods. Individual investors should consult with certified tax professionals to fully understand their tax obligations in relation to annual REIT dividend payments.
Sources:
1. 2021 Tax Brackets, Tax Foundation, https://taxfoundation.org/publications/federal-tax-rates-and-tax-brackets/
2. A Short Lesson on REIT Taxation, Simply Safe Dividends, https://www.simplysafedividends.com/intelligent-income/posts/18-a-short-lesson-on-reit-taxation
3. The Basics of REIT Taxation, Investopedia, https://www.investopedia.com/articles/pf/08/reit-tax.asp
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. It should also not be construed as advice meeting the particular investment needs of any investor. 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. There is no guarantee that companies that can issue dividends will declare, continue to pay, or increase dividends. A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. 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.
