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.
Is REIT income considered earned income?
While most REIT dividends are taxed as regular income, those who qualify can take advantage of a substantial tax cut.
REIT dividends, in particular, are widely regarded as pass-through income, similar to money made by an LLC and distributed to its shareholders. The qualified business income deduction, or QBI deduction for short, was created by the Tax Cuts and Jobs Act. This is known as the pass-through deduction because it allows taxpayers to deduct up to 20% of their income from pass-through sources. Ordinary income distributions from REITs are also eligible.
How do REITs avoid taxes?
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.
How are REITs taxed in Canada?
The revenue and gains from a REIT’s property rental operation are not taxed in Canada. Instead, when a REIT’s property revenue is dispersed, shareholders are taxed on it, and some investors may be excluded.
Where do I report REIT income on tax return?
Each year, if you own REIT shares, you should receive a copy of IRS Form 1099-DIV. This shows how much money you got in dividends and what kind of dividends you got:
The 1099-DIV instructions explain how to report each type of payment on your tax return.
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.
Are REITs taxable in an IRA?
“According to financial journalist Reuben Gregg Brewer, “if you possess REITs in an IRA, you won’t have to pay taxes on that income until you pull money out of the IRA.” “You’ll pay taxes in any year you receive distributions if you own the same REITs in a standard brokerage account.
How are REIT index funds taxed?
How are dividends from REIT ETFs taxed? After the 20% qualifying business income deduction is applied to those distributions, most REIT ETF dividends will be taxed at your regular income tax rate. Some REIT ETF earnings may be subject to capital gains tax, which will be reported on Form 1099-DIV.
How do REITs distribute income?
REITs must pay out at least 90% of their taxable revenue to shareholders in the form of taxable dividends every year. To put it another way, a REIT cannot keep its profits. A REIT, like a mutual fund, is eligible for a dividends-paid deduction, which means that if 100% of revenue is distributed, no tax is paid at the entity level.
Weak Growth
REITs that are publicly listed are required to pay out 90% of their profits in dividends to shareholders right away. This leaves little money to expand the portfolio by purchasing additional properties, which is what drives appreciation.
Private REITs are a good option if you enjoy the idea of REITs but want to get more than just dividends.
No Control Over Returns or Performance
Investors in direct real estate have a lot of control over their profits. They can identify properties with high cash flow, actively promote vacant rentals to renters, properly screen all applications, and use other property management best practices.
Investors in REITs, on the other hand, can only sell their shares if they are unhappy with the company’s performance. Some private REITs won’t even be able to do that, at least for the first several years.
Yield Taxed as Regular Income
Dividends are taxed at the (higher) regular income tax rate, despite the fact that profits on investments held longer than a year are taxed at the lower capital gains tax rate.
And because REITs provide a large portion of their returns in the form of dividends, investors may face a greater tax bill than they would with more appreciation-oriented assets.
Potential for High Risk and Fees
Just because an investment is regulated by the SEC does not mean it is low-risk. Before investing, do your homework and think about all aspects of the real estate market, including property valuations, interest rates, debt, geography, and changing tax regulations.
Fees should also be factored into the due diligence process. High management and transaction fees are charged by some REITs, resulting in smaller returns to shareholders. Those fees are frequently buried in the fine print of investment offerings, so be prepared to dig through the fine print to find out what they pay themselves for property management, acquisition fees, and so on.
Can I hold a REIT in my TFSA?
According to Royal LePage, the cost of a single-family home in Canada increased 14.1 percent year over year in the first quarter of 2021. This comes after a year of exceptional house demand, with month after month of sales and price appreciation records. Saving for a down payment on a home in Toronto might take as long as 24 years for a family with average income. The housing market in Vancouver isn’t much better, with most housing alternatives requiring a family to earn more than $150,000 per year.
Those that entered the market early and profited handsomely are now sitting on large sums of money. For the previous two decades, the average price of a home in the United States has increased by 6% every year. When you combine that rate of return with historically low interest rates and reasonable mortgages, it’s easy to see why so many seasoned landlords have amassed multi-million-dollar fortunes.
Let’s take the smart money’s advice. To get into this lucrative market, you don’t need to follow the typical route of requiring a down payment or mortgage approval. You can put your TFSA money into a Real Estate Investment Trust (REIT) (REIT). REITs are eligible to be invested in through existing or new TFSA accounts because they are registered funds. As a result, you’ll be able to invest in real estate while still contributing to your TFSA, making it a win-win situation.
REITs benefit from special tax status and are very tax efficient. Generally, you can postpone paying taxes until you sell your REIT investment, giving you more money to spend or reinvest each year.
If you’re searching for a safe, predictable, and tax-efficient monthly income, a private REIT is an excellent option.
A tax-free savings account (TFSA) is a scheme that began in 2009 and allows people aged 18 and above to put money aside tax-free for the rest of their lives. Even if you didn’t start a TFSA in 2009, you still have annual contribution room.
To put it another way, a TFSA allows you to save money without paying taxes on the growth or withdrawals from the account. However, just around half of Canadians are believed to have started a TFSA, so let’s look at the benefits.
The most major advantage of a TFSA is that any investment income earned by Canadians is not taxed. Unlike an RRSP, your savings will not only grow tax-free, but you will not be taxed on the withdrawal as well.
Another reason TFSAs are so appealing to Canadians is that your income has no bearing on your contribution limit! This is not the case with an RRSP, where the amount you can contribute each year is precisely proportional to your income.
Your contribution space will not be used up. There’s no need to fret if investors don’t use their whole TFSA contribution quota; the balance will be carried over to the next year.
Withdrawing funds from your TFSA is a breeze. This is not the case with RRSPs, where you must deal with difficulties such as withholding taxes, purchasing annuities, and opening RRIFs.
When you invest in a REIT with your TFSA, you receive exposure to the stock upside as well as leverage. In other words, purchasing these funds is similar to engaging a team of pros to buy real estate on your behalf. Given the current status of Canadian real estate, including a private REIT in your TFSA is an excellent idea for future investments.
