To qualify for REIT classification and avoid paying corporate taxes, a company must meet a number of requirements. REITs must spend at least 75 percent of their assets in real estate, generate at least 75 percent of their revenue from real estate, and have at least 100 shareholders, to mention a few requirements. Any publicly traded REIT, private REIT, or public non-traded REIT is subject to all of these rules. They are equally applicable to stock REITs and mortgage REITs.
However, distributions are by far the most well-known criterion. REITs are obligated to transfer at least 90% of their taxable income to their shareholders. After all, REITs often provide a greater dividend yield than the S&P 500 average stock. If they do this, they will be treated as pass-through organizations by the IRS, and their profits will not be subject to corporate income tax. This also means that REIT payouts are often considered as regular income for shareholders, rather than qualified dividends, which are taxed differently than stock dividends.
How much does a REIT have to pay out?
A REIT is a security that invests directly in real estate and/or mortgages, comparable to a mutual fund. Mortgage REITs engage in portfolios of mortgages or mortgage-backed securities, whereas equity REITs invest mostly in commercial assets such as shopping malls, hotel hotels, and office buildings (MBSs). A hybrid REIT is a fund that invests in both. REIT shares are easy to buy and sell because they are traded on the open market.
All REITs have one thing in common: they pay dividends made up of rental income and capital gains. REITs must pay out at least 90% of their net earnings as dividends to shareholders in order to qualify as securities. REITs are given special tax treatment as a result of this; unlike a traditional business, they do not pay corporate taxes on the earnings they distribute. Regardless of whether the share price rises or falls, REITs must maintain a 90 percent payment.
Do REITs have to pay 90%?
How do you become a REIT? A corporation must have the majority of its assets and income linked to real estate investment and must distribute at least 90% of its taxable income to shareholders in the form of dividends each year to qualify as a REIT.
What is a good payout ratio for REITs?
For all dividend stocks, the payout ratio is an important indicator. There are, however, two REIT-specific things to be aware of.
To begin, make sure you’re calculating the payout ratio using FFO rather than net income or earnings per share. FFO is a more accurate indicator of a REIT’s profitability.
Second, whereas most investors seek payout ratios of 40–50% for traditional dividend companies, REIT payout ratios are sometimes significantly higher. This is due to the fact that REITs must pay out the majority of their profits.
A REIT with an FFO payout ratio of 80%, for example, isn’t cause for concern. There’s no reason to fear a REIT’s payout is too high or unsustainable as long as the ratio stays below 100 percent.
Are REITs obligated to pay dividends?
This page contains a detailed explanation of what makes a REIT a REIT. However, there are two fundamental ideas that must be understood in order to proceed with this discussion:
To qualify as a REIT, a real estate business must pay out at least 90% of its taxable income.
Second, if a corporation fulfills the REIT criteria, it is exempt from paying corporate taxes.
Here’s why these two rules are so crucial. REITs are not only required to pay out practically all of their taxable income, but they are also exempt from corporate taxation if they do so.
Let’s imagine a REIT makes a $10 million taxable profit to demonstrate why this is such a significant gain. By definition, it must pay out at least $9 million in dividends to stockholders.
A typical (non-REIT) firm, on the other hand, makes a profit of $10 million in 2019. After taxes, based on a corporation tax rate of 21%, there will be $7.9 million remaining. Even if this corporation decided to transfer 90% of its income to its shareholders, the total would be around $7.1 million. The difference is over $2 million less than the REIT.
Finally, when it comes to dividends, there are some distinctions between equity REITs and mortgage REITs. As you can see from the graph above, Annaly Capital Management pays more than twice as much as the next highest payment on the list. Annaly is a REIT that invests in mortgages.
Equity REITs generate income as well as stock price appreciation. Rental revenue is generated by commercial properties, which also tend to appreciate in value over time. Mortgage-backed securities, on the other hand, are purchased solely for the purpose of generating income. Within specified risk constraints, mortgage REITs deliver the largest amount of income. They are unconcerned about the potential for their assets to appreciate.
Which REITs pay the highest dividend?
For income investors, the beauty of REITs is that they are obligated to release 90% of their taxable income to shareholders in the form of dividends each year. REITs often do not pay corporate taxes in exchange.
As a result, several of the 171 dividend-paying REITs we follow have dividend yields of 5% or more.
Bonus: Watch the video below to hear our chat with Brad Thomas on The Sure Investing Podcast about sensible REIT investing.
However, not all high-yielding stocks are a sure bet. To ensure that the high yields are sustainable, investors should carefully examine the fundamentals. This post will go through ten of the highest-yielding REITs on the market with market capitalizations over $1 billion.
While the securities discussed in this article have exceptionally high yields, a high yield on its own does not guarantee a good investment. Dividend security, valuation, management, balance sheet health, and growth are all critical considerations.
We advise investors to take the research below as a guide, but to conduct extensive due diligence before investing in any security, particularly high-yield securities. Many (but not all) high yield securities are at risk of having their dividends cut and/or their business outcomes deteriorate.
High-Yield REIT No. 10: Omega Healthcare Investors (OHI)
Omega Healthcare Investors is one of the most well-known healthcare REITs that focuses on skilled nursing. Senior home complexes account for around 20% of the company’s annual income. The company’s financial, portfolio, and management strength are its three primary selling factors. Omega is the market leader in skilled nursing facilities.
High-Yield REIT No. 9: Apollo Commercial Real Estate Finance (ARI)
In 2009, Apollo Commercial Real Estate Finance, Inc. was established. It’s a debt-oriented real estate investment trust (REIT) that invests in senior mortgages, mezzanine loans, and other commercial real estate-related debt. The underlying real estate properties of Apollo’s investments in the United States and Europe serve as collateral.
Hotels, Office Properties, Urban Pre-development, Residential-for-sale inventory, and Residential-for-sale construction make up Apollo Commercial Real Estate Finance’s multibillion-dollar commercial real estate portfolio. Manhattan, New York, the United Kingdom, and the rest of the United States make up the company’s portfolio.
High-Yield REIT No. 8: PennyMac Mortgage Investment Trust (PMT)
PennyMac Mortgage Investment Trust is a real estate investment trust (REIT) that invests in residential mortgage loans and related assets. PMT
Why are REITs a bad investment?
Real estate investment trusts (REITs) are not for everyone. This is the section for you if you’re wondering why REITs are a bad investment for you.
The major disadvantage of REITs is that they don’t provide much in the way of capital appreciation. This is because REITs must return 90 percent of their taxable income to investors, limiting their capacity to reinvest in properties to increase their value or acquire new holdings.
Another disadvantage is that REITs have very expensive management and transaction costs due to their structure.
REITs have also become increasingly connected with the larger stock market over time. As a result, one of the previous advantages has faded in value as your portfolio becomes more vulnerable to market fluctuations.
Do REITs have tax advantages?
Understanding the tax implications of investing in a Real Estate Investment Trust (REIT) is one of the most important factors when adding commercial real estate investments to a well-balanced portfolio approach “When analyzing various options, REITs may be beneficial. Currently, Jamestown is offering Jamestown Invest 1, LLC (the) (the) (the) (the) (the) (the) (the) (the) “Fund”), which is available to accredited and non-accredited investors in the United States. The Fund is established as a REIT with the goal of acquiring and managing a portfolio of real estate investments in urban infill regions that are expected to grow. By the end of this article, you should be able to spot potential REIT tax benefits and better interpret your 1099-DIV form, as well as understand a few IRS rules relevant to REIT investments.
What is a REIT?
The United States Congress first introduced REITs in 1960. Until then, institutional investors were the only ones who could invest in commercial real estate. Most people lacked the financial means or resources to make important and diverse investments in the space. The REIT structure was designed by Congress to address this imbalance. Individual investors were able to pool assets and make major investments in commercial real estate by investing in a REIT.
You may have also heard that REITs are a time-consuming vehicle to manage, and this is correct! It is not, however, without justification. Congress has set various restrictions on the structure and operation of REITs in order to ensure that they meet their legislative goals. The REIT must maintain certain levels of investment in real estate assets and earn particular levels of income from real estate and other passive vehicles in order to be considered a passive real estate investor. There are special shareholder criteria and constraints on the concentration of ownership of REIT shares to ensure that money are pooled by individual investors. REITs that meet these criteria receive preferential tax treatment (discussed in more detail below).
How Are Realized Returns Determined?
Before going into some of the tax advantages of investing in a REIT fund, it’s crucial to understand how commercial real estate trusts create profits for investors. Operating distributions and capital gain distributions are the two components of real estate realized returns.
- Investors receive operating distributions (usually monthly or quarterly) from the cash flow generated by the fund’s underlying real estate investments. This is usually achieved by net rental income or portfolio income from the REIT, such as interest and dividends.
- The capital gain from the sale of real estate within the REIT is the second component of realized returns potential.
How Are Realized Returns Categorized?
A REIT must transfer the bulk of its taxable income to its shareholders in order to maintain its beneficial tax status. REIT distributions are classified into one of the following types. There is a different tax treatment for each category.
- Capital Gains — depending on whether the investment or its underlying property is kept for less than or more than 12 months, capital gains are taxed at a short-term or long-term capital gain rate.
If you recall from our post on How to Invest in Real Estate with a Self-Directed IRA, if you own a REIT in a tax-deferred account like a regular IRA, you only pay taxes on the money when you remove it.
What Are the Potential Tax Benefits of Investing in a REIT?
REITs are eligible for special tax treatment if they meet the IRS’s standards. Eligible REIT structures, unlike other U.S. corporations, are not subject to double taxation. Dividends provided to shareholders help REITs avoid paying corporate income tax. Shareholders may then benefit from preferential US tax rates on REIT dividend distributions.
The Tax Cuts and Jobs Act (TCJA), which was signed into law in 2017, made REIT investing even more tax-efficient. Many taxpayers are eligible for a tax deduction of up to 20% for Qualified Business Income under the TCJA, subject to specified income criteria. Ordinary REIT dividends, interestingly, qualify as Business Income for this reason, and REIT dividends aren’t subject to the income thresholds, thus REIT investors can take advantage of this provision regardless of their income!
The qualified business income deduction is equal to the lesser of (1) 20% of combined qualified business income or (2) 20% of taxable income minus the taxpayer’s net capital gain amount (if any).
The hypothetical after-tax return shown below is based on a $10,000 investment with a 7% yearly dividend yield. We’ll assume a single tax filer who has no capital gains and is in the highest federal marginal tax rate of 37 percent in 2020.
Will I Receive a Schedule K-1 or Form 1099-DIV?
Investors frequently inquire about whether they will receive a 1099 or a K-1 at the start of the year. While a Sponsor’s Investor Relations or Tax Team can provide this information, there are some general standards to be aware of before investing.
A REIT, brokerage, bank, mutual fund, or real estate fund issues Form 1099-DIV to the Internal Revenue Service. Persons who have received dividends or other distributions of $10 or more in money or other property will get Form 1099-DIV. Dividend income is taxed in the state(s) where the person resides, regardless of the location of the property.
Schedule K-1 is an annual tax form issued by the Internal Revenue Service for a partnership investment. Schedule K-1 is used to report each partner’s portion of the partnership’s profit, loss, deductions, and credits. Real estate partnership income may be taxed in the state(s) where the property is located. A Schedule K-1 is identical to a Form 1099 in terms of tax reporting.
Understanding your IRS Form 1099-DIV
If you invest directly in a REIT, you will receive a 1099-DIV from the REIT. You’ll find that numerous boxes on your Form 1099-DIV have already been filled in. Some of the reporting boxes and their ramifications were recently detailed in an article released by TurboTax, a market leader in tax software for preparing US tax returns.
- The percentage of box 1a that is considered qualified dividends is reported in box 1b.
- If you get a capital gain distribution from your investment, you must record it in box 2a.
- If any state or federal taxes were withheld from your dividends, report them in boxes 4 and 14 for federal withholding and state withholding, respectively.
REITs that comply with the law are exempt from paying corporate taxes. Ordinary and capital gain dividend income are taxed at the REIT shareholders’ respective tax rates. Ordinary dividends paid by REITs can be deducted up to 20% before income tax is calculated.
Built-in diversification without the hassle of several state income tax forms is an advantage of investing in a fund with exposure to multiple properties. In comparison to investing in numerous individual properties via partnerships, investors will only pay state taxes on their dividends and capital gains in their individual state(s) of residence.
While many people are aware with publicly traded REITs that offer the tax benefits we’ve discussed, combining some of these benefits with non-correlative private real estate may be a viable option for investors looking for a more diversified portfolio. Alternative investments have been a part of many high-net-worth individuals’ and institutions’ portfolios for decades, but they are still not a portfolio staple for many people.
Do REITs pay capital gains taxes?
Dividend payments are assigned to ordinary income, capital gains, and return of capital for tax reasons for REITs, each of which may be taxed at a different rate. Early in the year, all public firms, including REITs, must furnish shareholders with information indicating how the prior year’s dividends should be allocated for tax purposes. The Industry Data section contains a historical record of the allocation of REIT distributions between regular income, return of capital, and capital gains.
The majority of REIT dividends are taxed as ordinary income up to a maximum rate of 37% (returning to 39.6% in 2026), plus a 3.8 percent surtax on investment income. Through December 31, 2025, taxpayers can deduct 20% of their combined qualifying business income, which includes Qualified REIT Dividends. When the 20% deduction is taken into account, the highest effective tax rate on Qualified REIT Dividends is normally 29.6%.
REIT dividends, on the other hand, will be taxed at a lower rate in the following situations:
- When a REIT makes a capital gains distribution (tax rate of up to 20% plus a 3.8 percent surtax) or a return of capital dividend (tax rate of up to 20% plus a 3.8 percent surtax);
- When a REIT distributes dividends received from a taxable REIT subsidiary or other corporation (20% maximum tax rate plus 3.8 percent surtax); and when a REIT distributes dividends received from a taxable REIT subsidiary or other corporation (20% maximum tax rate plus 3.8 percent surtax); and when a REIT distributes dividends received from
- When allowed, a REIT pays corporation taxes and keeps the profits (20 percent maximum tax rate, plus the 3.8 percent surtax).
Furthermore, the maximum capital gains rate of 20% (plus the 3.8 percent surtax) applies to the sale of REIT stock in general.
The withholding tax rate on REIT ordinary dividends paid to non-US investors is depicted in this graph.
What are the tax advantages of a REIT?
REIT shareholders’ income tax obligations might be complicated. Each distribution, or dividend payout, received by taxable account holders is made up of a mix of cash obtained by the REIT from a variety of sources and classifications, each with its own set of tax implications.
REIT dividends are frequently made up of the company’s operating earnings. As a proportional owner of the REIT firm, this profit is passed through to the shareholder as ordinary income and is taxed as nonqualified dividends at the investor’s marginal tax rate.
REIT dividends may, on occasion, comprise a portion of operational earnings that was previously tax-free due to depreciation of real estate assets. A nontaxable return of capital, often known as the ROC, is a portion of the dividend that is not taxed. While it lowers the dividend’s tax burden, it also lowers the investor’s per-share cost basis. The tax liability of current income generated by REIT dividends will not be affected by a fall in cost basis, but it will increase taxes due when the REIT shares are eventually sold. This provision may give income planning options for persons with higher taxable income in the near future, such as the potential to smooth income over numerous years.
Capital gains may make up a component of REIT dividends. This occurs when a firm makes a profit on one of its real estate properties. The length of time the REIT business had that particular asset before selling it determines whether the capital gains are considered short-term or long-term. The shareholder’s short-term capital gains liability is equal to their marginal tax rate if the asset was held for less than a year. Long-term capital gains rates apply if the REIT holds the property for more than a year; investors in the 10% or 15% tax brackets pay no long-term capital gains taxes, while those in all but the highest income group pay 15%. Long-term capital gains will be taxed at 20% for shareholders in the highest income tax level, which is now 37%.
Tax benefits of REITs
Through the end of 2025, current federal tax regulations provide for a 20% deduction on pass-through income. Individual REIT owners are allowed to deduct 20% of their taxable REIT dividend income (but not for dividends that qualify for the capital gains rates). There is no deduction limit, no minimum wage requirement, and itemized deductions are not required to enjoy this benefit. For a person in the highest tax band, this provision (qualified business income) effectively lowers the federal tax rate on ordinary REIT dividends from 37 percent to 29.6 percent.
A word on current tax reform
On April 28, the Biden administration proposed a $1.5 trillion increase in individual taxes to assist defray the costs of a huge family and economic infrastructure investment. Many of the tax plans are similar to hikes in tax rates for high-income earners that were proposed during the campaign.
Congress is currently debating infrastructure initiatives and negotiating potential legislation’s structure and text. This procedure will take up a significant portion of the closing months of 2021, and if passed, it will very certainly affect the tax rates of high-income individuals.
Closing thoughts
When looking into the world of REITs, it’s critical to grasp the potential rewards and requirements. The regulations of REIT taxes are unique, and depending on the situation, shareholders may incur different tax rates. As usual, you should seek advice from your own tax, legal, and investment professionals, as each person’s situation is unique.
Can you get rich investing in REITs?
There is no such thing as a guaranteed get-rich-quick strategy when it comes to real estate equities (or pretty much any other sort of investment). Sure, some real estate investment trusts (REITs) could double in value by 2021, but they could also swing in the opposite direction.
However, there is a proven way to earn rich slowly by investing in REITs. Purchase REITs that are meant to grow and compound your money over time, then sit back and let them handle the heavy lifting. Realty Income (NYSE: O), Digital Realty Trust (NYSE: DLR), and Vanguard Real Estate ETF are three REIT stocks in particular that are about the closest things you’ll find to guaranteed ways to make rich over time (NYSEMKT: VNQ).
Do all REITs pay monthly dividends?
REITs that pay out on a regular basis. While most REITs pay quarterly dividends, certain REITs pay monthly dividends. This can be beneficial to investors, whether the money is used to increase income or to reinvest, because more frequent payments compound more quickly.
