What Is a REIT Dividend Tax Rate? - 1031 Crowdfunding (2024)

What Is a REIT Dividend Tax Rate? - 1031 Crowdfunding (1)

A real estate investment trust (REIT) is a popular option among investors looking for a passive income strategy that can help hedge against inflation. REITs are companies or institutions that buy and manage income-producing properties, such as hotels or retail centers. When you become a shareholder in a REIT, you receive distributions in the form of dividends.

REITs must pay shareholders a minimum of 90% of their taxable income. However, you might be wondering how these dividends will impact your tax liabilities. Generally, dividends are taxable to shareholders at the ordinary income tax rate, which is proportionate to your income. This article explains everything you need to know about how REIT dividends are taxed so you can invest with more confidence.

What Are the Different Types of REITs?

There are several different types of REITs you can invest in. Each one operates slightly differently and has a unique purpose, so you may find that one suits your financial goals better than the others.

  • Equity REITs: This type of REIT focuses on buying real estate properties to generate rental income. This income provides shareholders with dividends and pays for the upkeep of the properties. This type of REIT can be further categorized as a public or private REIT.
  • Mortgage REITs: An mREIT, also called a debt REIT, does not directly own real estate properties. Instead, this type of REIT invests in mortgages and mortgage-backed securities (MBS) and provides financing for mortgaging real estate properties. Investors in mREITs can focus on lending money for real estate mortgaging and earn interest from it. This can be referred to as the earnings generated by the net interest margin, or the spread between the interest earned on the mortgage loans and the cost of funding the loans. However, the spread between short-term and long-term interest rates does not tend to stay wide for long. As a result, mortgage REITs can be sensitive to interest rate fluctuations — specifically increases.
  • Hybrid REITs: As its name suggests, a hybrid REIT is a combination of an equity REIT and mREIT. In this case, the REIT will buy and own real estate properties and also invest in mortgages.

How Do REITs Pay Dividends?

The U.S. Securities and Exchange Commission (SEC) requires REITs to distribute at least 90% of their yearly income to shareholders. However, some REITs may pay dividends quarterly or monthly, which is something you’ll want to consider when searching for a REIT to invest in. As a shareholder, you can receive dividends in the form of cash or additional shares. However, each REIT has specific requirements and policies, such as whether shareholders can request dividends in cash only.

For instance, publicly traded REITs must provide elective stock dividends, meaning they can distribute earnings in a mixture of cash and stock as long as at least 20% is paid in cash. This combination allows REITs to save money while still fulfilling their requirement to pay dividends.

REITs must adhere to the 90% dividend rule, but this does not necessarily mean that shareholders will receive very large payouts. REITs have various payout ratios, meaning the dividend distribution is based on the company’s net income and whether it increases or decreases. For instance, a payout ratio of 20% means the REIT pays shareholders 20% in dividends per every dollar of net income.

What Are Ordinary and Qualified REIT Dividends?

What Is a REIT Dividend Tax Rate? - 1031 Crowdfunding (2)

The primary difference between qualified and ordinary dividends is that shareholders can report qualified dividends to the IRS as a capital gain instead of income. By default, all dividends distributed by a REIT are considered ordinary, or non-qualified, and are taxed as ordinary income. REIT dividends can be qualified if they meet certain IRS requirements. The Jobs and Growth Tax Relief Reconciliation Act of 2003 separated dividends into these classes.

Depending on the taxpayer, reporting capital gains can result in significant tax savings that an investor would otherwise owe on the dividends. Ordinary dividends are taxed at the regular federal and state income tax rates. However, qualified dividends are taxed based on the shareholder’s individual tax bracket, which could be 0%, 15%, or 20%.

For example, if a shareholder receives $2,000 in dividends from a REIT and receives the 15% qualified dividend tax rate, they will pay $300 in taxes. For particularly high earners who are subject to net investment income tax (NIIT), the REIT dividend tax rate can go up to 23.8%.

For dividends to be considered qualified, the shareholder must hold a preferred stock for more than 60 days within a 121-day period that begins 60 days before the ex-dividend date for common stock. The ex-dividend date is the cutoff date when the stock price does not include the upcoming dividend payment.

In other words, it’s the last date you can purchase a stock and receive the next dividend. The seller receives the dividend if you purchase the stock on or after the ex-dividend date.

If the shareholder purchases the stock after this date, it is considered an ordinary dividend. In addition to this required holding period, the qualified dividend must be from the U.S. or a qualified foreign corporation.

While qualified dividends receive favorable tax treatment, some investors may view the required holding period as a disadvantage.

How Are REITs Taxed?

While you now know that ordinary dividends are taxed at the ordinary income tax rate and qualified dividends are taxed at the investor’s marginal tax rate, you should know a few other elements about REIT taxation. In some cases, all dividends distributed by a REIT may be classified as ordinary income. Aside from ordinary income, there are two ways that REIT dividends can be taxed:

  • Capital gains earnings: If the REIT you invest in makes its profit from selling real estate property or assets and distributes this as a dividend, it is subject to capital gains tax. Capital gains can be taxed at short- or long-term rates. Short-term gains are taxed as ordinary income. Long-term rates are generally between 0% and 20% and depend on the investor’s income, regardless of how long a shareholder has been invested in the REIT.
  • Return of capital: For dividends to be categorized as return of capital (ROC), the REIT would distribute money back to you that you previously invested. While shareholders don’t have to pay tax on ROC dividends right away, they reduce their per-share cost basis. This leads to a larger capital gains tax later if they sell their REIT shares.

REIT shareholders can view a breakdown of their dividends on the 1099-DIV form they receive for each brokerage account they have. Another essential component to consider if you wish to achieve maximum REIT tax efficiency is the qualified business income (QBI) deduction. Because REIT dividends are considered small business income, investors can potentially deduct up to 20% of their QBI on their taxes. As of 2023, the total taxable income limit to qualify for this deduction is $182,100 for filing individually and $364,200 for filing jointly.

This material should not be construed as tax advice and you should consult with your tax advisor as individual tax situations will vary.

Learn More About Investing in REITs With 1031 Crowdfunding

Investing in REITs can help diversify your portfolio, reduce your hands-on responsibilities with actual properties, and provide tax advantages. Before choosing a REIT, consider your financial goals and weigh your options with the many different types of REITs available today. At 1031 Crowdfunding, our mission is to help investors like you learn about all the scenarios they might encounter before deciding on an investment.

As a real estate investment platform, we make it easier to view REIT investment options and equip you with the resources you need to make better-informed decisions. Register with 1031 Crowdfunding today to view all of our investment properties. We also invite you to learn more about investing in REITs and other alternative investments on our blog.

This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees and other expenses. This literature must be accompanied by, and read in conjunction with, a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results and forward-looking statements and projections are not guaranteed to achieve the results described and your actual returns may vary significantly. Investments in private placements are illiquid in nature and there may be no secondary market or ability to sell the investment should the need for liquidity arise. Securities offered through Capulent, LLC Member FINRA, SIPC.

What Is a REIT Dividend Tax Rate? - 1031 Crowdfunding (2024)

FAQs

What Is a REIT Dividend Tax Rate? - 1031 Crowdfunding? ›

REITs must pay shareholders a minimum of 90% of their taxable income. However, you might be wondering how these dividends will impact your tax liabilities. Generally, dividends are taxable to shareholders at the ordinary income tax rate, which is proportionate to your income.

What is the tax rate for REIT dividends? ›

The majority of REIT dividends are taxed as ordinary income up to the maximum rate of 37% (returning to 39.6% in 2026), plus a separate 3.8% surtax on investment income. Taxpayers may also generally deduct 20% of the combined qualified business income amount which includes Qualified REIT Dividends through Dec.

How do I report REIT dividends on my taxes? ›

Use Form 1120-REIT, U.S. Income Tax Return for Real Estate Investment Trusts, to report the income, gains, losses, deductions, credits, certain penalties; and to figure the income tax liability of a REIT.

What is a qualified REIT dividend? ›

Qualified dividends are a particular type of dividend you can report on taxes as a capital gain instead of income. Capital gains typically have lower tax rates than income taxes, allowing for increased savings when you file taxes.

How do you calculate REIT dividends? ›

Combine the total amount of dividends the REIT paid over one year. You can estimate annual dividends by multiplying quarterly distributions by 4 or monthly distributions by 12. Divide this number by the REITs current share price. Multiply this number by 100 to change it into a percentage.

Are REIT dividends double taxed? ›

That means REITs avoid the dreaded “double-taxation” of corporate tax and personal income tax. Instead, REITs are sheltered from corporate taxes so their investors are only taxed once.

Should you reinvest REIT dividends? ›

Conclusion: REITs offer investors an opportunity to invest in real estate without actually owning any property themselves. And by reinvesting their REIT dividends through a DRIP plan, investors can compound their gains and generate a higher rate of return than they would from other stocks.

Does a REIT file a tax return? ›

Generally, a REIT must file its income tax return by the 15th day of the 4th month after the end of its tax year.

Are REIT dividends passive income? ›

Investing in REITs can be a passive, income-producing alternative to buying property directly. However, investors shouldn't be swayed by large dividend payments alone.

How do I get my money out of a REIT? ›

Since most non-traded REITs are illiquid, there are often restrictions to redeeming and selling shares. While a REIT is still open to public investors, investors may be able to sell their shares back to the REIT. However, this sale usually comes at a discount; leaving only about 70% to 95% of the original value.

What is the difference between a REIT dividend and a stock dividend? ›

Over the long term, a basket of top dividend stocks can outperform a basket of REITs for three simple reasons: REITs dilute their own shares to raise more cash, they're designed to generate steady income instead of capital appreciation, and they're more sensitive to interest rates than more diversified companies.

Why are REIT dividends not qualified? ›

Generally, dividends from REITs are automatically exempt from being qualified dividends. Whether dividends are qualified depends on the nature of the investment that earned the money being passed along to shareholders.

What is the difference between qualified and nonqualified REIT dividends? ›

REIT Tax Policy

Most REIT distributions are considered non-qualified dividends, which means that they do not qualify for the capital gains tax rate. In most cases, an individual will have a 15% capital gains rate on qualified dividends and will be charged their regular income tax rate for non-qualified dividends.

What is an example of a REIT dividend? ›

For example, say an investor purchased 100 shares of a REIT at $20 a share, and it pays a $200 monthly dividend. The share price declines to $15 when the investor receives her first monthly dividend payment of $200, and it is reinvested in the REIT.

How are REIT earnings taxed? ›

A REIT is taxable as a regular corporation, but is entitled to the dividends paid deduction. Therefore, a REIT does not pay federal income tax on net taxable income distributed as deductible dividends to shareholders. Net income from foreclosure property is taxed at 35 percent.

How often are REIT dividends paid out? ›

REITs and stocks can both pay dividends, usually on a monthly, quarterly, or yearly basis. Some investments will also offer special dividends, but they're unpredictable. There is a difference between the dividends paid by stocks and REITs though.

Are REITs 90% taxable income? ›

In general, REITs do not pay taxes at the trust level insofar as they distribute 90% of their income to shareholders. Of course, REITs that follow this rule still pay corporate taxes on any retained income.

What percent of its taxable profits does a REIT have to pay out? ›

A REIT is required to pay a dividend of at least 90 percent of its taxable income each year.

What is the tax policy of a REIT? ›

2 In the United States, REITs are required to pay at least 90% of taxable income to unitholders. 1 This makes REITs attractive to investors seeking higher yields than what can be earned in traditional fixed-income markets.

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