A comprehensive guide to REIT taxation

As it relates to REITs, depreciation basically serves as a tax deferral mechanism. The greater the amount of depreciation expense, the more likely it is that the taxable portion of the REIT dividends will decrease. Also, the REIT may have to file Form 8865 to report certain dispositions by a foreign partnership of property it previously contributed to that foreign partnership if it was a partner at the time of the disposition.

• Any distribution of this profit to investors will either be considered short-term or long-term capital appreciation.
• There are certain safe harbors to follow in order to avoid a sale being deemed a prohibited transaction.
• To the extent that contributions are used to reduce taxable income for this purpose and increase an NOL carryover, a contributions carryover is not allowed.
• Some industrial REITs focus on specific types of properties, such as warehouses and distribution centers.
• Generally, a REIT must use the accrual method of accounting if its average annual gross receipts for the 3 prior tax years exceed $27 million.
• For example, the dividends earned are taxed differently than capital gains, just as they would if you invested in stocks or bonds.
• They are not tax efficient and an investor should consult with his/her tax advisor prior to investing.

If enough capital is returned to the investor and the cost basis falls to zero, any further non-dividend distributions are taxed as a capital gain. The U.S. government has used the tax code to encourage investors to participate in real estate gains since the creation of real estate investment trusts in 1960. As was the case in the 2017 Tax Cuts and Jobs Act, more tax benefits continue to emerge for REIT investors with each new draft of the tax code.

What’s a REIT?

These real estate companies have to meet a number of requirements to qualify as REITs. Most REITs trade on major stock exchanges, and they offer a number of benefits to investors. A return of capital lowers the investor’s cost basis in an asset. In other words, if you paid $50 per share for a https://turbo-tax.org/ REIT, and it distributed $1 as a non-taxable return of capital, your cost basis (the price you effectively paid) would be reduced to $49. So, while this won’t result in a tax bill for the distribution, it can make your capital gains tax bill higher when you eventually sell the REIT shares.

• If the REIT claims a credit for any wages paid or incurred, it may need to reduce any corresponding deduction for officers’ compensation and salaries and wages.
• On the line following the dollar sign, enter the amount from Form 8996, line 15.
• A REIT that has dissolved must generally file by the 15th day of the 4th month after the date it dissolved.
• This deduction is the mechanism by which REITs avoid double taxation inherent in C corporations.
• REITs simplify state tax reporting for individuals since the state income tax consequences and filing requirements of multistate real estate portfolios do not pass through the REIT to the investor.

However, these dividends reduce your cost basis in your REIT investment. The upshot of this is that when you sell your REIT shares, you might have a larger taxable capital gain. In other words, return of capital means no tax now, but potentially more tax later. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action.

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. This is a major reason income investors value REITs over many other dividend-paying companies. Any dividends taxed at your ordinary income tax rate depend on your tax bracket.

It is expected that changes will take effect from April 2023 and will include removal of the requirement that the REIT must own at least three properties where the REIT holds a single commercial property worth at least £20 million. Michael Torhan is a Tax Partner in the Real Estate Services Group. He provides tax compliance and consulting services to clients in the real estate, hospitality, and financial services sectors.

The Basics of REIT Taxation

That’s because investment returns in such plans are not taxed when earned. Some REITs are hybrids, involved in both kinds of activities. https://turbo-tax.org/the-basics-of-reit-taxation/ REITs generally don’t pay taxes themselves as long as they distribute at least 90% of their income to shareholders.

Instead, include the amount of interest owed on Schedule J, line 7, Other taxes. A member of a controlled group must check the box on line 1 and complete and attach Schedule O (Form 1120). See Schedule O (Form 1120) and its instructions for more information. Deduct only those expenses that have a proximate and primary relationship to the earning of the income shown on line 1. Do not deduct general overhead and administrative expenses in Part IV. Section 857(b)(6) imposes a tax equal to 100% of the net income derived from prohibited transactions.

The investor would pay ordinary income taxes on the $1.20 in the year in which it was received. Meanwhile, the investor’s cost basis is reduced by $0.60 to $19.40 per share. As stated previously, this reduction in basis will be taxed as a either long- or short-term gain or loss when the units are sold. REITs, like many companies, distribute earnings to investors in the form of dividends. Unlike many companies however, REIT incomes are not taxed at the corporate level.

In addition, a portion of the dividend may be listed as a nontaxable return of capital. This can happen when the REIT’s cash distributions exceed earnings, for example, when the company takes large depreciation expenses. One, this part of the dividend is not taxable in the year in which it is paid to the unitholder. This payment is taxed as either a long- or short-term capital gain or loss when the investor sells their units.