Yes, you generally pay taxes on your investments in Real Estate Investment Trusts (REITs), primarily on the dividends they distribute and on any capital gains realized from selling your shares. While REITs themselves often receive favorable tax treatment by avoiding corporate income tax (provided they distribute at least 90% of their taxable income to shareholders), this income then becomes taxable at the individual investor level.
How REIT Income is Taxed
Understanding the different ways REIT income can be taxed is crucial for investors. There are two primary categories where taxes apply: dividend distributions and the sale of REIT shares.
Taxation of REIT Dividends
REITs are known for their high dividend yields, but these dividends are not always taxed uniformly. This is a key difference from qualified dividends received from many regular corporations. REIT dividends can be taxed at different rates because they can be allocated to ordinary income, capital gains, and return of capital.
- Ordinary Income Dividends (Non-Qualified): A significant portion of REIT dividends are typically classified as non-qualified ordinary income. This means they are taxed at your marginal income tax rate, which can be higher than the rates for qualified dividends or long-term capital gains. These often come from the REIT's operational income.
- Capital Gains Dividends: Less commonly, a portion of REIT dividends might be designated as capital gains dividends. These are generally taxed at the more favorable long-term capital gains rates. This typically occurs when the REIT sells a property for a profit and distributes that gain to shareholders.
- Return of Capital Dividends: Sometimes, a portion of a REIT's distribution may be considered a "return of capital." This part of the dividend is generally not taxed immediately. Instead, it reduces your cost basis in the REIT shares. Your tax liability is deferred until you sell your shares, at which point a lower cost basis could result in a larger taxable capital gain.
Taxation on Selling REIT Stock
When you sell your REIT shares, any profit you make is considered a capital gain, and this gain is subject to taxation. The tax rate applied depends on how long you held the shares:
- Short-Term Capital Gains: If you hold the REIT shares for one year or less before selling, any profit is considered a short-term capital gain and is taxed at your ordinary income tax rate.
- Long-Term Capital Gains: If you hold the REIT shares for more than one year, any profit is considered a long-term capital gain. These gains are typically taxed at more favorable rates. The maximum capital gains tax rate of 20% (plus the 3.8% Medicare Surtax) applies generally to the sale of REIT stock, for those in higher income brackets.
Summary of REIT Tax Implications
| Type of Income | Tax Treatment | Key Point |
|---|---|---|
| REIT Dividends | Varies by allocation | Can be ordinary income (taxed at regular rates), capital gains (taxed at long-term capital gains rates), or return of capital (reduces cost basis, defers tax). |
| Sale of REIT Stock | Capital Gains (Short-term or Long-term) | Short-term gains are taxed at ordinary income rates. Long-term gains are taxed at favorable rates, with a maximum capital gains tax rate of 20% plus a 3.8% Medicare Surtax for higher earners. |
Practical Considerations for REIT Investors
- Tax-Advantaged Accounts: Many investors choose to hold REITs within tax-advantaged accounts like a Roth IRA or traditional IRA. In a Roth IRA, qualified distributions are tax-free, including REIT dividends. In a traditional IRA, taxes are deferred until withdrawal in retirement. This can help mitigate the impact of ordinary income dividend taxation.
- Tax Reporting: You will receive Form 1099-DIV from your brokerage, which breaks down the different types of REIT dividends (ordinary, qualified, capital gains, and return of capital) to help you accurately report your income.
- Consult a Professional: Given the complexities of REIT taxation, especially with varying dividend classifications, it's often beneficial to consult a tax advisor to understand the specific implications for your personal financial situation.
