If you’re considering investing in Real Estate Investment Trusts (REITs), it’s important to understand the US taxation rules that apply to them. REITs are a popular investment vehicle that allows investors to invest in a portfolio of income-generating real estate properties without actually owning the properties themselves. As such, they are subject to specific taxation rules that differ from those that apply to other types of investments. In this article, we’ll provide an overview of the US taxation of REITs and what you need to know before investing in them.

What is a REIT?

A REIT is a company that owns, operates, or finances income-generating real estate properties. REITs were created by Congress in 1960 to allow smaller investors to invest in real estate without the high costs and management requirements of owning property directly. There are two types of REITs: equity REITs and mortgage REITs. Equity REITs own and operate income-generating real estate properties, while mortgage REITs invest in mortgages or mortgage-backed securities.

US Taxation of REITs

REITs are required to distribute at least 90% of their taxable income to their shareholders each year in the form of dividends. As a result, REITs themselves are generally not subject to federal income tax on the income they generate. Instead, shareholders of REITs are taxed on their share of the REIT’s income at their individual tax rates.

Dividends paid by REITs are generally classified as ordinary income, although a portion may be classified as qualified dividends and taxed at lower capital gains rates. Additionally, shareholders may be subject to the Net Investment Income Tax (NIIT) of 3.8% on their REIT dividends if their income exceeds certain thresholds.

It’s also important to note that if a REIT distributes more than its taxable income to shareholders, the excess distribution is considered a return of capital and not taxed as income. However, it reduces the shareholder’s basis in the REIT stock, which could result in higher capital gains taxes when the stock is sold.

Finally, non-US investors in REITs are subject to a withholding tax of 30% on their dividends unless a lower treaty rate applies.

Tax Planning for REIT Investors

Investing in REITs can be a tax-efficient way to generate income, but it’s important to plan accordingly. Because REIT dividends are taxed at ordinary income rates, it may be beneficial to hold REITs in tax-advantaged accounts like IRAs or 401(k)s. Additionally, because REIT dividends may be subject to the NIIT, it’s important to consider the impact on your overall tax liability.

Investors should also be aware of the potential for a return of capital distribution, which could affect their basis in the REIT and increase capital gains taxes when the stock is sold.

Conclusion

REITs can be a valuable investment vehicle for those looking to invest in real estate without owning property directly. However, it’s important to understand the US taxation rules that apply to REITs to make informed investment decisions. If you’re considering investing in REITs, consult with a tax professional to develop a tax-efficient investment strategy.