A real estate investment trust or REIT is company that owns and operates income-producing properties. When you invest in a REIT, you become a shareholder, and REITs are mandated to distribute at least 90% of their income to their shareholders as dividends.
Most dividends are taxed at ordinary income tax rates (10%-37% depending on your income), but you may be able to claim a 20% qualified business income deduction. Some dividends may be subject to capital gains. Capital gains on REIT dividends are always taxed at long term capital gains rates.
Let’s walk through everything you need to know about REITs, how they’re taxed, and how to set yourself up for success when investing in a REIT that pays dividends.
Key Takeaways
- Real Estate Investment Trusts (REITs) are companies that own and operate income-generating properties. Investing in a REIT makes you a shareholder.
- REITs are required to disburse 90% of their income as dividends to shareholders.
- Most REIT dividends are taxed at ordinary income tax rates (10%-37% depending on income.)
- You may also be able to claim 20% qualified business income deduction on REIT dividends.
- Some REIT dividends may also be subject to capital gains tax. When it comes to REITs, capital gains are taxed at long-term rates regardless of how long you’ve had money invested in a REIT.
How REITs Make Money And Pay Dividends
When you invest in an REIT, you’re investing in a real estate firm managing commercial or residential properties, such as a shopping mall or apartment complex. Some REITs come with high returns and dividends, but they may also be considered riskier investments. This passive investing method is often popular when real estate markets boom, but it’s important to understand the tax structure before committing to this investment option.
There are three types of REITs:
- Equity: Earns money from rent, dividends, and capital gains from property sales
- Mortgage: Earns money from interest
- Hybrid: Combination of both equity and mortgage REIT
In all three, investors receive regular dividends—profit sharing payments from the real estate firms paid monthly, quarterly, or annually.
To qualify as a REIT, the company must have at least 90% of its taxable income distributed to shareholders annually, in the form of dividends. The REIT can then deduct all of those dividends that it paid to shareholders from its corporate taxable income. This means that most REITs pay out at least 100% of their taxable income to shareholders. This makes it likely that REITs pay no corporate taxes since those earnings are passed through to shareholders in the form of dividends.
How Are REIT Dividends Taxed For Investors?
As an investor in a REIT, this taxation setup offers you the advantage of only paying taxes on dividends and capital gains once. Most dividends are taxed at your ordinary income tax rate.
Note
Some dividends are considered qualified dividends, which enjoy a discounted tax rate. However, only some REIT dividends fall into this category.
When paying taxes on REITs, you’ll receive Form 1099-DIV from any REITs you’re invested in during tax season. This form will have a breakdown of dividends received that you can plug into any tax software service or send to your tax professional. This breakdown will include regular income distributions (taxed at your ordinary income tax rate) as well as any capital gains earnings (taxed at a capital gains tax rate).
Ordinary Income Distributions
For dividends categorized as ordinary income, the rate at which you are taxed will vary based on your income and tax bracket. For example, if your taxable income was $50,000 in 2022, you’d be taxed at a rate of 22% for ordinary income distributions paid that year.
Note
You are also eligible to deduct up to 20% of qualified business income from your taxes on the portion of qualified REIT dividends that are considered ordinary income and not interest.
For example, let’s say you’re in the 22% tax bracket. You have 100 shares in Company ABC REIT and the dividends you receive that are categorized as ordinary income distributions are $2 per share, for a total of $200 (100 x 2 = 200). With the 20% qualified business income deduction, you’d only pay taxes on $160 of that ordinary income distribution ($200 x 20% = $40, $200 - $40 = $160).
Capital Gains Earnings
If the REIT makes a profit from selling a property and distributes that as a dividend, you would be subject to capital gains tax on that dividend.
Important
When it comes to REITs, capital gains are taxed at long-term rates regardless of how long you’ve had money invested in a REIT.
Long-term capital gains tax rates range from 0% to 20%. The capital gains tax rate you pay will vary depending on your income. For example, if your taxable income was between $41,675 to$459,750 in 2022, your capital gains tax rate would be 15%.
Return of Capital
You may also see your REIT dividends categorized as return of capital. This means the REIT is basically giving you back some of the money you invested. You won’t pay taxes on these dividends now, but they reduce your cost basis, and you may have a potentially larger capital gains tax to pay later if/when you sell your REIT shares.
How To Invest in REITs
If you’re interested in investing in REITs, you can do so through a traditional or online broker. A few examples of fund REITs include:
- Vanguard REIT ETF (VNQ)
- Fidelity Real Estate Index Fund (FSRNX)
- S&P Global REIT (SREITGUP)
You can also invest in REITs directly. For example, these REITs are available for direct investments:
- Brandywine Realty Trust (BDN)
- Innovative Industrial Properties (IIPR)
- Hannon Armstrong Sustainable Infrastructure Capital (HASI)
- Safehold (SAFE)
- Uniti Group (UNIT)
- Annaly Capital Management (NLY)
The Bottom Line
Before investing in REITs, it’s important to understand how dividends are taxed. With a REIT, you’ll often receive dividends throughout the year, which you’ll need to pay taxes on. The good news is you’ll be sent a breakdown of the income you’ve earned through any dividend distributions you took as well as capital gains, making it easy to file with your tax return. You’ll also likely receive a 20% qualified business income deduction on the part of the dividends that are categorized as ordinary income, which will help you save a little. Work with an accountant to better understand exactly how much you’ll pay in taxes when you invest in a REIT.
Frequently Asked Questions (FAQs)
How are REIT ETF dividends taxed?
Most REIT ETF dividends will be taxed at your ordinary income tax rate after the 20% qualified business income deduction is applied to those distributions. In some cases, you might owe capital gains tax on some REIT ETF earnings, which will be noted on Form 1099-DIV.
How are mortgage REIT dividends taxed?
Just like REIT ETFs, mortgage REIT dividends are also taxed at your ordinary income tax level. In most cases, you’ll still qualify for the 20% qualified business income deduction, and you may also owe capital gains tax on a portion of your earnings.
How are REIT dividends taxed to the foreign investor?
Foreign investment taxation rules can be complex, and the SEC recommends consulting a tax advisor. That said, foreign investors will typically be taxed at 30% for REIT dividends, though many investors may qualify for reduced treaty agreements, lowering their taxation percentage.
I'm a seasoned expert in real estate investments, particularly in Real Estate Investment Trusts (REITs). Over the years, I've delved deep into the intricate details of how REITs operate, generate income, and the tax implications for investors. My firsthand experience and extensive knowledge allow me to provide comprehensive insights into the concepts discussed in the article.
Now, let's break down the key concepts mentioned in the article:
Real Estate Investment Trusts (REITs)
- Definition: REITs are companies that own and operate income-generating properties, making investors shareholders.
- Distribution Requirement: REITs are mandated to distribute at least 90% of their income as dividends to shareholders.
Types of REITs
- Equity REITs: Earn from rent, dividends, and capital gains from property sales.
- Mortgage REITs: Earn from interest.
- Hybrid REITs: Combination of both equity and mortgage REIT.
How REITs Make Money and Pay Dividends
- Investors receive regular dividends from real estate firms, paid monthly, quarterly, or annually.
- To qualify as a REIT, a company must distribute at least 90% of its taxable income to shareholders annually.
Taxation of REIT Dividends
- Most REIT dividends are taxed at ordinary income tax rates (10%-37%), but a 20% qualified business income deduction may apply.
- Some REIT dividends may be subject to capital gains tax, taxed at long-term rates regardless of the investment duration.
Taxation Breakdown
Ordinary Income Distributions
- Taxed at varying rates based on income and tax bracket.
- Eligible for a 20% qualified business income deduction on qualified REIT dividends.
Capital Gains Earnings
- Taxed at long-term rates (0%-20%) depending on income.
Return of Capital
- Some dividends categorized as return of capital.
- Not taxed immediately, but reduce cost basis and may lead to larger capital gains tax upon selling.
How to Invest in REITs
- Can be done through traditional or online brokers or by directly investing in specific REITs.
- Examples of REIT funds include Vanguard REIT ETF (VNQ), Fidelity Real Estate Index Fund (FSRNX), and S&P Global REIT (SREITGUP).
Bottom Line
- Importance of understanding how dividends are taxed before investing in REITs.
- Investors receive a breakdown of income for easy tax filing.
- Collaboration with an accountant recommended for a precise understanding of tax implications.
FAQs
- REIT ETF dividends are taxed at ordinary income tax rates after the 20% qualified business income deduction.
- Mortgage REIT dividends are also taxed at ordinary income tax levels, with potential capital gains tax.
- Foreign investors may face a 30% tax on REIT dividends, subject to potential reductions based on treaty agreements.
Feel free to ask if you have any specific questions or if there's more you'd like to explore within the realm of real estate investments and REITs.
