Real estate investment trusts are one way investors can own interests in commercial real estate without having to navigate the common management and operational issues that are associated with direct property ownership.
REITs are required to return at least 90 percent of all taxable income back to their shareholders as dividends; however, real estate produces different types of income, and each type receives different tax treatment.
In this article we’ll take a look at where investors who receive dividends are supposed to place REIT income on their tax returns. It can be a complicated process, though, so it’s best to work with a qualified tax professional when preparing your annual tax return.
How REIT Dividends are Taxed
REITs aren’t taxed like regular corporations because they meet two special conditions:
- The majority of assets and income are derived from real estate.
- They return 90 percent or more of taxable income back to shareholders as dividends.
Investors who receive dividends from a REIT will receive IRS form 1099-DIV, Dividends and Distributions, to report their qualified REIT dividends to the IRS. You can file this information via a Schedule B form or put it directly onto your Form 1040 tax return.
Here’s where it can get a bit tricky, because as mentioned earlier those dividend payments fall into three separate categories:
- Ordinary income -- this will be the bulk of your dividend payment, and it’s taxed as ordinary income according to your marginal tax rate.
- Capital gains -- Funds received when a REIT sells a property held for at least one year. They are taxed at 0, 15, or 20 percent depending on your annual income and filing status when the distribution was received.
- Return of capital -- Taxed at either long or short-term capital gains depending on how long you hold your shares in the REIT.
Your 1099-DIV will show how much you received from a REIT in each of these three income categories. There are two parts to “Box 1” of your 1099-DIV, one for ordinary and another for qualified dividends, which are taxed at a lower rate than ordinary dividends.
Any capital gains received from a REIT are always taxed as long-term gains -- it doesn’t matter how long you’ve held your shares of the REIT. These will be shown on Box 2a of your 1099-DIV. Lastly, return of capital is just that -- a return of your initial investment in the REIT. These dividends are not taxed and can be used to reduce the cost basis of your investment. They are reported on Box 3 of your 1099-DIV.
The Bottom Line
Determining how REITs are taxed and where to place dividend payments on your annual tax return can take some serious sleuthing. A qualified tax professional should be able to help you demystify the IRS Form 1099-DIV for dividends and distributions and ensure you’ve correctly identified each type of dividend paid out from your REIT investments.