A well-liked method for investors to own income-producing real estate without having to purchase or maintain property is through real estate investment trusts, or REITs. REITs are popular among investors because of their plentiful revenue streams. The trust must give shareholders a minimum of 90% of its taxable income in order to be classified as a REIT. As a result of paying dividends to investors, REITs usually do not have to pay corporation income taxes on their earnings.
REITs, or Real Estate Investment Trusts, are financial instruments that have been introduced by the U.S. Congress in 1960 to make real estate investing more accessible for average investors. These trusts pool capital from many investors to acquire, manage, and develop diverse properties, offering regular dividend payments and potential appreciation of the REIT’s share value.
REITs are available in more than 40 countries and have surpassed $2 trillion in market capitalization as of 2024. They fall into three categories: Equity REITs, Mortgage REITs, and Hybrid REITs. Equity REITs invest in real estate and derive income from rent, dividends, and capital gains from property sales. Mortgage REITs invest in mortgages and mortgage-backed securities, making them sensitive to interest rate changes. Hybrid REITs invest in both real estate and mortgages, but have largely fallen away since the 2007-2008 financial crisis.
Taxation at the trust level is unique for REITs, as they would be taxed as a corporation if not for their special REIT status. To meet the definition of a REIT, the bulk of its assets and income must come from real estate, and it must pay 90% of its taxable income to shareholders. This requirement means REITs typically don’t pay corporate income taxes, though any retained earnings would be taxed at the corporate level.
REITs, or Real Estate Investment Trusts, are a type of investment vehicle that provides investors with a steady income stream and higher yields than they might earn in fixed-income markets. The dividend payments REIT investors receive can constitute ordinary income, capital gains, or a return on capital. These dividends are broken down on the 1099-DIV that REITs send to shareholders yearly. The bulk of the dividend is income from the company’s real estate business and is treated as ordinary income to the investor. This part of the dividend is taxed according to the investor’s marginal tax rate.
The REIT may inform investors that part of the dividend is a capital gain or loss when the REIT sells property held for at least one year. The capital gain or loss is also passed along to the investor, with gains taxed at 0%, 15%, or 20%, depending on the investor’s income level for the year the gain was received. A part of the dividend may be listed as a nontaxable return on capital.
A return of capital is not taxable for the year it is paid to the unitholder but is taxed later. When the investor sells their units, this payment is taxed as either a long- or short-term capital gain or loss. If enough capital is returned to the investor and the cost basis falls to zero, any further non-dividend distributions are taxed as a capital gain.
The Tax Cuts and Jobs Act (TCJA) of 2017 gives a new 20% deduction for pass-through business income, which includes qualified REIT dividends. Non-U.S. residents should note that their REIT income could be subject to a 30% withholding tax. A reduced rate and exemption may apply if a tax treaty exists between the U.S. and the REIT holder’s country of residence.
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