REIT taxation differs from the tax treatment many investors associate with ordinary corporate dividends. Real estate investment trusts generally distribute a substantial portion of their taxable income, and those distributions can contain different tax components.
This guide explains the basic U.S. federal income tax framework for individual investors. Tax rules can change, and state taxes and individual circumstances can produce different outcomes, so current IRS guidance and the tax documents provided by the investment should be used when preparing a return.
Why REIT taxation is different
A qualifying REIT generally can deduct dividends paid to shareholders when calculating its taxable income, provided it meets the applicable REIT rules. This differs from a typical C corporation, which generally pays corporate income tax before distributing after-tax profits as dividends.
To qualify as a REIT, a company must satisfy several requirements. One of the best-known rules is that it generally must distribute at least 90% of its taxable income, excluding net capital gain, to shareholders each year.
You can learn more about the underlying structure in our guide to what a REIT is.
How REIT distributions can be classified
A cash payment from a REIT is not necessarily taxed entirely in one way. The tax character depends on what the REIT reports for the distribution.
| Possible component | General federal tax treatment |
|---|---|
| Ordinary REIT dividend | Generally taxed as ordinary income, subject to applicable rules and potential deductions |
| Capital gain distribution | Generally treated according to the applicable capital gains rules |
| Return of capital | Generally reduces the investor’s tax basis rather than being immediately taxed as dividend income, until basis is exhausted |
The REIT or broker reports the tax classification after the end of the year. Investors should therefore avoid assuming that every dollar received during the year will have the same tax treatment.
Ordinary REIT dividends
Many REIT dividends are not qualified dividends eligible for the preferential federal tax rates that can apply to qualifying dividends from certain corporations. Instead, ordinary REIT dividends are generally included in ordinary income.
However, eligible taxpayers may be able to deduct up to 20% of qualified REIT dividends under the qualified business income rules, subject to the law in effect for the relevant tax year and the taxpayer’s circumstances. Investors should verify current eligibility rather than assuming the deduction applies automatically.
Capital gain distributions
A REIT can realize capital gains when it sells properties or other investments. It may distribute some of those gains to shareholders and report them as capital gain distributions.
The tax treatment of these amounts differs from ordinary REIT dividends. The applicable rate can depend on the nature of the gain and current tax rules. Investors should rely on the year-end tax reporting provided for the investment when determining how a distribution should be reported.
Return of capital
Part of a REIT distribution may sometimes be classified as a nondividend distribution, commonly described as a return of capital. In general, this portion reduces the investor’s cost basis in the shares rather than being immediately included as dividend income.
Reducing the basis can increase a future taxable capital gain when the shares are sold. Once basis has been reduced to zero, additional nondividend distributions can have different tax consequences.
This illustrates why cash yield and taxable income are not the same thing. Two investors receiving identical cash distributions can also have different after-tax outcomes depending on their accounts and tax situations.
A simple REIT tax example
Suppose an investor receives $500 in total REIT distributions during a year. For illustration only, imagine the year-end tax information classifies $350 as ordinary REIT dividends, $100 as capital gain distributions, and $50 as return of capital.
The $350 and $100 portions would be handled according to their respective tax rules. The $50 return-of-capital portion would generally reduce the investor’s basis in the shares rather than being taxed immediately, assuming the investor still has sufficient basis.
This is only an example. Actual classifications are determined by the REIT’s tax reporting and can vary from year to year.
REITs in taxable vs tax-advantaged accounts
The account holding the REIT can affect when investment income creates a current tax liability. In a regular taxable brokerage account, taxable REIT distributions generally need to be reported for the year in which they are received.
Tax-advantaged retirement accounts follow different rules. Income and gains generated inside accounts such as traditional or Roth IRAs generally are not taxed in the same way as distributions received directly in a taxable brokerage account. Instead, the tax treatment depends on the rules governing the account and withdrawals.
This does not mean one account type is universally better for REITs. Investors need to consider their broader portfolio, account eligibility, withdrawal rules, and personal tax situation.
REIT ETFs and funds
Investors can also gain REIT exposure through ETFs and mutual funds. The fund receives distributions from its underlying holdings and then makes distributions to its own shareholders.
The tax reporting received by the investor is based on the fund’s distributions rather than simply mirroring each underlying REIT payment. Investors should use the tax forms and supplemental tax information provided by their broker or fund.
State and international tax considerations
Federal income tax is only one part of the picture. State income taxes can apply differently depending on where an investor lives and the relevant state rules.
International investors and U.S. investors holding foreign real estate companies can face additional withholding, treaty, and classification issues. These situations can become considerably more complex than the basic domestic REIT framework described here.
What documents should investors check?
Investors should use the tax documents issued by their broker, REIT, or fund rather than estimating the character of distributions themselves. Form 1099-DIV commonly reports dividend and distribution information for U.S. taxable accounts.
REITs and funds may also publish supplemental tax information that explains the final classification of distributions. Because these classifications can be determined after payments have already been made, the cash amount received during the year does not by itself reveal the final tax treatment.
Key takeaways
- REIT distributions can include ordinary dividends, capital gain distributions, and return of capital.
- Ordinary REIT dividends generally do not receive the same treatment as qualified corporate dividends.
- Eligible taxpayers may qualify for a deduction on certain REIT dividends under current federal tax rules.
- Return of capital generally reduces cost basis and can affect future capital gains.
- Tax-advantaged accounts can change when taxes are paid on REIT investment returns.
- Investors should rely on current IRS guidance and official year-end tax documents because tax rules and distribution classifications can change.