Tax Advantages of REITs Explained

REITs offer a unique tax advantage: they pass on the tax burden to shareholders, not the company itself. This is because REITs are required to distribute at least 90% of their taxable income to shareholders.

One of the key benefits of REITs is their ability to avoid double taxation, which can save investors a significant amount of money. REITs are not subject to corporate-level taxation, as long as they meet certain requirements.

Investors who hold REIT shares in a taxable brokerage account can expect to pay taxes on the dividends they receive, but the tax rate will be lower than if the income were earned directly by the company.

A Qualified Foreign Pension Fund (QFPF) can enjoy tax-free real estate appreciation and gain on exit by using a REIT.

Ordinary REIT dividends paid to QFPFs are subject to US-source withholding, but this can be reduced by treaty benefits.

Here are the tax benefits of REITs for QFPFs: REIT dividends consisting of gain on a real estate asset sale are untaxed.Sale of REIT shares generating a gain is untaxed.Sale or redemption of fund units where the fund owns only REIT shares is untaxed.

Publicly Traded REITs offer a lot of flexibility for investors. They can be purchased with ordinary brokerage accounts, making it easy to add them to your portfolio.

There are currently more than 200 publicly traded REITs available on the market. This wide range of options can help you find the right fit for your investment goals and risk tolerance.

Publicly traded REITs are regulated by the U.S. Securities and Exchange Commission (SEC) and must provide audited financial reports.

A Qualified Foreign Pension Fund (QFPF) can achieve tax-free appreciation on US real estate investments through a REIT. This is made possible by the special rules applying to QFPFs.

The complex Foreign Investment in Real Property Tax Act (FIRPTA) regime typically taxes non-US investors on indirect US real estate gains, but a QFPF can use a REIT to bypass this rule.

REIT dividends consisting of gain on a real estate asset sale are untaxed for a QFPF. This is a significant advantage for QFPFs looking to invest in US real estate.

Sale of REIT shares generating a gain is also untaxed for a QFPF. This means that QFPFs can sell their REIT shares without incurring taxes on the gain.

The following are untaxed for a QFPF, including where REIT shares are held indirectly through a fund:

Depreciation serves as a tax deferral mechanism for real estate investors.

The greater the amount of depreciation expense, the more likely it is that the taxable portion of the REIT dividends will decrease.

Depreciation effectively reclassifies certain dividends from "ordinary income" to "return of capital".

This means minimizing "ordinary income" dividends, which are taxed at the personal rate.

By maximizing the amount of income taxed at a 25% rate, you can reduce your tax liability.

The Pass-Through Deduction is a lucrative tax benefit for REIT investors. It allows them to deduct up to 20% of their dividends, saving them a significant amount of money on their tax bill.

Investors in the top tax bracket can see their tax bill for dividends go from 37% to 29.6%. This means they'll save up to $740 annually on $10,000 of REIT dividends. The math is simple: deduct 20% of the dividend income and tax only 80% of it.

Not every company qualifies for the Pass-Through Deduction, however. To be eligible, a company must be a passthrough entity and meet certain requirements, such as not being a "specified service trade or business." This typically includes doctors, dentists, and lawyers.

The Pass-Through Deduction is a significant advantage for REIT investors, allowing them to keep more of their earnings. By investing in REITs, investors can benefit from this tax break and potentially save thousands of dollars on their tax bill.

Here's a breakdown of the tax benefits for REIT investors:

Depreciation is a tax deferral mechanism that can help minimize the amount of dividend income taxed at the personal rate. It effectively reclassifies certain dividends from "ordinary income" to "return of capital".

The more depreciation expense a REIT has, the lower the taxable portion of the REIT dividends will be. This means less dividend income is taxed at the personal rate.

Depreciation works to minimize "ordinary income" dividends, which are taxed at a higher rate. This can result in a lower tax liability for investors.

The greater the amount of depreciation expense, the more likely it is that the taxable portion of the REIT dividends will decrease. This is because depreciation expense reduces the taxable income of the REIT.

To qualify as a REIT, a company must adhere to specific requirements. A REIT can be either a single company REIT or a group REIT, with the principal company being a UK resident company that is not resident in another jurisdiction at the same time.

A group REIT consists of a parent company plus all of its 75% subsidiaries, regardless of their tax residence. The REIT group is effectively the same group as the capital gains group.

Here are the main requirements for a REIT:

To qualify as a REIT, a company must meet certain requirements related to its structure and ownership. A REIT can be either a single company REIT or a group REIT.

A single company REIT must be a property investment company, while a group REIT consists of a parent company and its subsidiaries. The parent company must have an economic benefit of more than 50% in each subsidiary.

To be a group REIT, the parent company and its subsidiaries must be part of the same group as the capital gains group. The principal company of a group REIT or a single company REIT must be a UK resident company, which is not resident in another jurisdiction at the same time.

A group REIT consists of a parent company plus all of its 75% subsidiaries, regardless of their tax residence. The REIT group is effectively the same group as the capital gains group.

A REIT can only issue one class of ordinary shares, but it can issue other types of shares, such as convertible non-voting fixed rate preference shares, non-voting fixed rate preference shares, and convertible loan stock.

Here's a summary of the requirements for a REIT's structure:

As a REIT, you'll need to distribute a significant portion of your income to shareholders. 90% of your tax-exempt income from property rental businesses must be distributed within 12 months of the end of your accounting period.

This requirement doesn't apply to exempt gains or profits from residual business income. You can also pay stock dividends in lieu of cash dividends, which are treated as qualifying distributions.

There's an additional rule to keep in mind if you invest in another REIT. 100% of the PID dividends received by the investing REIT must be distributed within 12 months of the end of the accounting period.

Domestically Controlled Funds are a game-changer for non-US investors who want to monetize their investments efficiently.

In a fund setting, a domestically controlled REIT is more than 50% owned by US persons, which means it falls outside of the FIRPTA regime.

This allows non-US owners to sell REIT shares or partnership units holding REIT shares without incurring US tax.

In fact, this scenario can provide a smooth path for investor monetization, as they can sell REIT shares or partnership units without triggering FIRPTA withholding.

Non-US owners can also be redeemed from the partnership before a gain on sale dividend, which would have attracted FIRPTA withholding otherwise.

By contrast, there's no similar exception for partnerships owning real estate directly.

REITs offer a number of tax advantages that can benefit investors. Taxation with REITs can get complicated, but understanding the basics is key.

A key benefit of REITs is that they provide a single 1099-DIV tax form each January, which simplifies tax preparation for investors on platforms like Arrived.

For investors in the UK, a PID distribution is treated as profits of a UK property business, not a dividend, and is taxed accordingly.

As a UK-based investor, you need to understand your tax status and how it affects your investments. If you're within the charge to corporation tax or income tax, a Property Income Distribution (PID) distribution is treated as profits of a UK property business.

In the UK, tax laws can be complex, but it's essential to know how they impact your investments. A non-UK tax resident investor may be able to reclaim withholding tax suffered, depending on the relevant double tax treaty.

Distributions are a crucial aspect of REITs, and it's essential to understand how they work. A REIT must distribute 90% of its tax-exempt income from the property rental business within 12 months of the end of the accounting period.

REITs can pay stock dividends in lieu of cash dividends, and these are treated as qualifying distributions. This means that investors can receive new shares instead of cash, which can be beneficial for those who want to hold onto their shares.

Distributions out of exempt rental income and exempt gains are subject to a withholding tax of 20% in the UK, unless a reduced rate applies under a double tax treaty. This means that non-UK tax resident investors may be eligible for a lower withholding tax rate.

Here are the key requirements for REIT distributions:

It's worth noting that distributions can be complex, and each dividend payout may comprise a combination of funds from various sources and categories. This can make tax preparation more challenging, which is why it's often recommended to work with a financial advisor.

For non-US investors, direct investment in a REIT can be a problem due to withholding taxes on dividends. This can be particularly true when there's limited or no treaty relief.

A taxable C-corp blocker structure can be an efficient solution, using mezzanine debt leverage from investors or a feeder fund.

The 30% interest expense limitation can be a challenge, but it can be turned off for an electing real property trade or business (RPTOB). However, this exception may not be available to the blocker if it doesn't meet the requirements.

A captive feeder REIT can be used to place leverage, where the common stock is owned by the C-corp blocker. This setup allows the levered captive REIT to elect RPTOB status, making interest expense deductions unlimited.

If the lending feeder fund investor base is sufficiently dispersed, interest payments may enjoy a portfolio interest exception to withholding.

REITs offer a unique tax advantage that can benefit investors in lower tax brackets or those managing their taxable income through retirement or other tax-deferred accounts. This is because REIT income is only taxed at the individual shareholder level.

By distributing most of their income, REITs avoid double taxation, which means investors are only taxed once. This can be a major advantage over non-REIT corporations that distribute dividends, which are subject to corporate income taxes.

To illustrate this point, consider a REIT that distributes 90% of its income to investors, resulting in only $21,000 paid in federal corporate taxes, compared to a non-REIT corporation that distributes 50% of its income, resulting in $315,000 paid in federal corporate taxes.

REIT investors can save on taxes compared to traditional investments because a REIT in a taxable account has numerous useful tax benefits.

REITs are taxed differently than other asset classes, making them a smart choice for investors looking to minimize their tax liability.

A REIT has the ability to pass through certain tax benefits to its investors, including depreciation and amortization expenses.

This can result in a lower tax bill for REIT investors, making them more attractive to those seeking to save on taxes.

Many other asset classes do not offer the same level of tax benefits, making REITs a valuable addition to a diversified investment portfolio.

The IRC Section 199A deduction is a valuable tax benefit for investors in real estate investment trusts (REITs) and certain debt funds. It allows them to deduct 20% of their qualified business income.

This provision was made possible by the Tax Cuts and Jobs Act of 2017, which created new tax benefits for REIT investors. Specifically, it allows REIT investors to deduct up to 20% of their dividends.

Not every company qualifies for this deduction, however. In addition to being a pass-through entity, a company cannot be a "specified service trade or business", which usually includes doctors, dentists, and lawyers.

Rental real estate and certain debt funds may produce qualified business income for their partners, which would produce a 20% partner-level deduction for individual investors. This provision is scheduled to sunset after 2025 unless extended by congress.

REITs, with no wage and UBIA limits, produce ordinary dividends which categorically qualify for the 20% deduction—subject to further shareholder or partner level limitations.

A state blocker can be a significant advantage for REIT investors, particularly those in zero- or low-income tax states. This is because REITs can distribute dividends to investors without being subject to state withholding taxes, reducing administrative costs and improving cash flow.

REITs can operate properties in multiple states, but individual or trust shareholders only pay taxes on the dividends in their state of domicile, with no added investor state filings or liabilities.

For investors domiciled in states with high income taxes, a REIT can be a game-changer, allowing them to avoid paying taxes on their dividend income in those states. This can result in substantial tax savings for investors.

In some cases, non-US investors may prefer a taxable C-corp blocker with mezzanine debt leverage, which can be an efficient way to avoid withholding taxes on dividend income. This structure can also provide unlimited interest expense deductions, subject to certain conditions.

A captive feeder REIT can be used to achieve this structure, where the common stock is owned by the C-corp blocker and the feeder REIT owns a proportion of the main REIT shares. This can be an effective way to leverage the main REIT while minimizing tax liabilities.

For non-UK tax resident investors, a PID distribution is treated as a dividend for the purposes of any relevant double tax treaty.

This can make it possible for the investor to reclaim withholding tax suffered, but the "holders of excessive rights" rules may limit this possibility.

A non-UK tax resident investor holding 10% or more of a REIT may be able to access lower treaty rates.

REITs can also facilitate reporting simplification and interest expense efficiencies for funds investing in rental real estate located outside the United States.

By placing rental real estate assets beneath a US REIT, funds can enjoy several benefits, including reduced complex partnership investor reporting.

This can be especially helpful for rental real estate operating in a non-US entity, where filing US tax returns and required elections can be burdensome.

US REIT ordinary dividends are categorically qualified for the 20% IRC Section 199A deduction, regardless of the geography of the operations.