Series 7: 7.2.3. Taxation Of Income From REITs

7.2.3. Taxation of Income from REITs

There are three kinds of REIT distributions in terms of how they are treated for tax purposes: non-qualified dividends are treated as ordinary income, qualified dividends are treated as long-term capital gains, and return of capital reduces the investor’s cost basis instead of being taxed when distributed. REITs are required to provide their shareholders with an IRS Form 1099-DIV that allocates the prior year’s earnings for tax purposes.

The biggest portion of a REIT’s distributions will typically be non-qualified dividends, and therefore designated as ordinary income, which is taxed at the investor’s ordinary tax rate. Therefore, REITs may be best owned in a tax-advantaged plan, such as an IRA or 401(k), and may be less suitable for individuals in high tax brackets. The Tax Cuts and Jobs Act of 2017 created a new 20% individual income tax deduction on many types of income from pass-through entities such as REITs and DPPs. This deduction is available even to individuals who do not itemize deductions.

REIT distributions from the sale of capital assets, such as buildings, are known as qualified dividends. Shareholders are taxed on qualified dividends at long-term capital gains rates.

The third type of distribution is a return of capital distribution. Return of capital distributions are dividends that are drawn from invested capital rather than from earnings. Return of capital distributions may be made when a REIT has lowe