A Brief Beginner’s Guide on REIT Taxation
Carl E. Sera, CMT
June 29, 2023
Real estate investment trusts (REITs) are a helpful investment tool for creating passive income. But what goes into REIT taxation? Here’s our quick beginner’s guide to REIT taxation.
What Are REITs?
REITs are favorable investment tools for investors who desire to own income-generating real estate properties without needing to purchase or manage properties. Investors praise REITs due to their generous income avenues.
Qualifying for a REIT involves trusts distributing at least 90 percent of their taxable income to designated shareholders. As such, REITs do not pay corporate income taxes due to earnings getting passed along as dividend payments.
Types of REITs
There are three types of REITs: Equity, Mortgage, and Hybrid. Equity REITs allow trusts to invest in real estate, deriving income from dividends, property sale capital gains, and rent, making for a popular REIT.
Mortgage REITs involve trusts investing in mortgage-backed securities and mortgages, which earn interest from investments, but remain sensitive to interest rate changes.
Hybrid REITs invest in both mortgages and real estate.
Before getting involved in REITS, it’s essential to recognize how REIT taxation works and how it can impact an investor. There are two types of REIT taxation: at a trust level and a unitholder level.
REITs could get taxed as a corporation if it were not for their special REIT status. Most assets and income must originate from real estate to meet a REIT. Furthermore, at least 90 percent of taxable income must go toward shareholders.
As such, REITs don’t pay corporate taxes, but any retained earnings would get taxed at a corporate level. REITs must invest at least 75 percent of their assets into cash and real estate while obtaining 75 percent of gross income from mortgage interest and rent.
Dividend payments received by REIT investors can constitute capital gains, capital returns, or ordinary income. The 1099-DIV states that REITs send to shareholders each year, as much of the dividend gets passed-along income from the company’s real estate business; therefore, treated as ordinary income. As such, the specific dividend becomes taxed.
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