The ability of REITs to provide exposure to income-generating property ownership without the investor actually owning the real estate is just one of the many reasons why REITs have become so popular with many investors. But not all the dividend payments that are made by these investments are considered dividends. The tax status of these REITs varies depending on the kind of payment and account.
Here’s a complete guide for you to understand REIT taxation basics, how it works, and how it differs.
A REIT is an entity that is involved in owning, operating, or financing real estate assets that meet certain criteria set by US tax law. For a REIT to be able to qualify for REIT status, it should distribute not less than 90% of its REIT taxable income to the stockholders, subject to certain limitations set out in the tax law. The advantage of such arrangement is that the REIT can be able to make deductions of qualifying dividends it pays and thereby avoids paying corporate income tax on the income distributed.
Such tax treatment makes the REIT distribution different from corporate dividend payments because while a corporation may have to pay taxes on its income before distributing after-tax income to the stockholders, a REIT would normally pass taxable income to the stockholders, who will declare such distributions according to their nature.
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IT depends on how the REIT classifies each part of its distribution and whether the shares are held in a taxable or tax-advantaged account.
| Distribution Type | Normal Federal Income Tax Treatment in a Taxable Account |
| Ordinary REIT dividends | Normally subject to the investor's ordinary income tax rate |
| Capital gain distribution | Often considered long-term capital gain, subject to any rules that might apply |
| Return of capital | Normally results in reducing the cost basis of the investment; taxation would occur upon sale of the shares |
| Qualified dividends, if applicable | Usually eligible for reduced qualified dividend rates if statutory conditions are met |
This is generally true, but there can be additional taxes levied by the state. The investor needs to know the difference between dividends and profits.
Most REIT distributions are reported as ordinary income from REITs. Unlike qualified dividends, dividends from REITs are typically considered ordinary income from REITs. They are usually not qualified dividends of corporations; hence, they are not entitled to the special tax rate that applies to qualified dividends from corporations.
The tax rate is dependent on the taxable income, among other factors, meaning that even if two people receive $1,000 in dividends from the same REIT, their tax liabilities may vary due to differences in filing status and other conditions.
There could be a case where some dividends from a REIT may be deductible under Section 199A based on the law and your qualifications. The qualified dividends from REITs would be reported in Box 5 of Form 1099-DIV. It should be noted that this deduction is different from the lower tax rates for qualified dividends.
It is somewhat difficult to understand the expression REIT qualified dividends since “qualified REIT dividends” and “qualified dividends” are different tax classes.
While most ordinary dividends paid by REITs do not qualify for the special lower rates applicable to qualified dividend income, a REIT can designate a certain part of its dividends as qualified dividend income, provided that they satisfy the corresponding conditions. Capital gain dividends also belong to a separate class. To make an appropriate comparison, one should take into account only those categories of dividends which the REIT or a brokerage firm will classify as qualified.
When the stock has been purchased in a taxable account through the help of a broker, the broker will give you Form 1099-DIV, which will have details about the dividends and distributions paid by the company or REITs. The boxes that will interest you are as follows:
Do not add up these boxes as they are overlapping. For example, Box 5 is part of Box 1a, but it is not an additional dividend apart from Box 1a.
For certain long-term investors, a Roth IRA may be a tax-efficient way to invest in REITs, as the money earned within the account is not subject to annual income tax liability. Qualified distributions from the IRA are typically tax-free, under certain conditions.
Roth IRA does not eliminate the risk associated with investment or ensure better performance. Contributions to the Roth IRA are capped each year; there are also restrictions on earnings withdrawals.
In a taxable account, dividends from the REITs may generate annual tax liabilities regardless of the decision to reinvest these dividends. In a traditional IRA, funds grow in a tax-deferred manner; however, the treatment of withdrawals differs.
The investor does not control the classification of distributions made by the REIT, although he or she can plan for their outcome.
Changes in tax regulations and the requirements of deduction eligibility depend on the current tax year.
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REITs provide investors with an opportunity to make money from the income produced by the real estate business via public stocks, although the taxation on their dividends is not always similar to regular stock dividends. Most of the ordinary dividends distributed by REITs are taxable as income; however, there are other types of distributions that should be handled differently.
REIT dividends, in a taxable brokerage account, will normally be taxed in the year received regardless of whether they are reinvested automatically or not. The treatment could be different for tax-favored retirement accounts.
Ordinary REIT dividends are normally not eligible for special tax rates available to qualified dividend income. A REIT can elect some of its dividends as qualified dividend income, hence the need to confirm your annual tax statements.
Box 5 shows the Section 199A dividends, which can be part of the ordinary dividends shown in Box 1a. They may be deductible as per the prevailing tax rules.
Return of capital generally reduces the shareholder’s cost basis rather than being taxed immediately as dividend income. A lower basis can increase the taxable gain when the shares are sold, and basis cannot generally be reduced below zero.
It depends on your eligibility, time horizon, withdrawal plans, and overall portfolio. A Roth IRA can shelter eligible investment income from current federal tax, while a taxable account offers different access and tax considerations. Compare both with your broader plan.
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