REIT distributions offer a unique set of tax advantages compared to ordinary dividends from other corporations. These advantages stem from the REIT’s special tax status under the Internal Revenue Code, which allows REITs to avoid corporate-level taxation as long as they meet specific requirements—most notably, distributing at least 90% of taxable income to shareholders. Below are the main tax benefits investors receive through REIT distributions:
1. Avoidance of Double Taxation
- Unlike regular C-corporations, REITs are not taxed at the corporate level if they distribute 90% or more of their taxable income to shareholders.
- As a result, REIT income is generally taxed only once—at the shareholder level, avoiding the double taxation typically associated with traditional dividends.
- This structure enhances overall tax efficiency and net yield to investors.
2. Qualified Business Income (QBI) Deduction (Section 199A)
- A significant tax benefit for REIT shareholders is the 20% QBI deduction introduced by the Tax Cuts and Jobs Act (2017).
- Investors may deduct 20% of REIT ordinary dividends from their taxable income, subject to limitations.
- This deduction applies to non-qualified dividends (which REITs typically issue) and helps lower the effective tax rate.
- For individuals in higher tax brackets, this can significantly enhance after-tax income.
3. Capital Gains Treatment on Certain Distributions
- Some portion of REIT distributions may be designated as long-term capital gains (e.g., from asset sales).
- These are taxed at favorable rates (15% or 20%, depending on income level), rather than ordinary income rates.
- This portion is identified on the Form 1099-DIV issued by the REIT each year.
- Capital gain distributions provide a tax-efficient return component, especially for high-net-worth investors.
4. Return of Capital (ROC) Components
- A portion of distributions may be classified as return of capital, especially in development-stage or asset-heavy REITs.
- ROC is not immediately taxable; instead, it reduces the investor’s cost basis in the shares.
- Taxes are deferred until the shares are sold, at which point the reduced basis increases the capital gain.
- This deferral strategy supports tax planning and long-term investment optimization.
5. Eligibility for Tax-Advantaged Accounts
- REIT shares can be held in IRAs, Roth IRAs, and other retirement accounts, shielding distributions from current-year taxation.
- In Roth IRAs, qualified withdrawals are entirely tax-free, making REITs a high-yield option for long-term retirement planning.
- In traditional IRAs, taxes are deferred until withdrawal, offering compounding advantages.
