Can you avoid capital gains by investing in a REIT?
If the REIT held the property for more than one year, long-term capital gains rates apply; investors in the 10% or 15% tax brackets pay no long-term capital gains taxes, while those in all but the highest income bracket will pay 15%.
Taxes & REIT Investment
The maximum capital gains tax rate of 20% (plus the 3.8% Medicare Surtax) applies generally to the sale of REIT stock.
Avoiding REIT dividend taxation
If you own REITs in an IRA, you won't have to worry about dividend taxes each year, nor will you have to pay taxes in the year in which you sell a REIT at a profit. In a traditional IRA, you won't owe any taxes until you withdraw money from the account.
Individuals can currently deduct 20% of the pass-through income coming from REIT investments. This can incentivize you to invest in a REIT right now as you may pay significantly less in taxes than you would have before this benefit was provided. There is no guarantee that this tax benefit will be extended beyond 2025.
Risks of investing in REITs include higher dividend taxes, sensitivity to interest rates, and exposure to specific property trends.
To qualify as a REIT, a company must have the bulk of its assets and income connected to real estate investment and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.
While a steady flow of payments may sound enticing, REIT dividends come with unique tax consequences for investors. These payments can constitute ordinary income, capital gains, or a return of capital—each of which receives different tax treatment.
A REIT will be closely held if more than 50 percent of the value of its outstanding stock is owned directly or indirectly by or for five or fewer individuals at any point during the last half of the taxable year, (this is commonly referred to as the 5/50 test).
Unlike partnerships which are flow-through entities for tax purposes, REITs generally avoid entity-level tax by virtue of receiving a dividends paid deduction and by effectively being required to distribute all of their earnings and profits each year.
REITs and REIT Funds
Real estate investment trusts are a poor fit for taxable accounts for the reason that I just mentioned. Their income tends to be high and often composes a big share of the returns that investors earn from them, as REITs must pay out a minimum of 90% of their taxable income in dividends each year.
Are REITs double taxed?
Unlike many companies however, REIT incomes are not taxed at the corporate level. 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.
By default, all dividends distributed by a REIT are considered ordinary, or non-qualified, and are taxed as ordinary income. REIT dividends can be qualified if they meet certain IRS requirements.
Capital gains distributions occur when a REIT sells real estate assets and realizes a profit. Unlike ordinary dividends, these distributions are treated like any other capital gain and subject to preferential rates.
In most cases, REITs utilize a combination of debt and equity to purchase a property. As such, they are more sensitive than other asset classes to changes in interest rates., particularly those that use variable rate debt. When interest rates rise, REITs share prices can be prone to volatility.
With rate cuts on the horizon, dividend yields for REITs may look more favorable than yields on fixed-income securities and money market accounts. However, REIT stocks are only as good as the properties they own — and some real estate sectors may be better positioned than others.
REITs historically perform well during and after recessions | Pensions & Investments.
REITs should generally be considered long-term investments
This is especially true if you're planning to invest in non-traded REITs since you won't be able to easily access your money until the REIT lists its shares on a public exchange or liquidates its assets. In many cases, this can take around 10 years to occur.
According to the National Association of Real Estate Investment Trusts (Nareit), non-traded REITs typically require a minimum investment of $1,000 to $2,500.
For purposes of the REIT income tests, a non-qualified hedge will produce income that is included in the denominator, but not the numerator. This is generally referred to as “bad” REIT income because it reduces the fraction and makes it more difficult to meet the tests.
While a REIT is still open to public investors, investors may be able to sell their shares back to the REIT. However, this sale usually comes at a discount; leaving only about 70% to 95% of the original value. Once a REIT is closed to the public, REIT companies may not offer early redemptions.
Do REITs generate passive income?
Keep in mind that though you can earn passive income from REIT dividends, the IRS does not tax these dividends as passive income. Instead, the income you earn from REIT dividends is usually taxed as ordinary income.
While buying a rental property can be a good way to make some passive income, REITs are way easier. They're very low-cost and completely passive.
For Group REITs, the consequences of leaving early apply when the principal company of the group gives notice for the group as a whole to leave the regime within ten years of joining or where an exiting company has been a member of the Group REIT for less than ten years.
Sec. 199A allows taxpayers to deduct 20% of their qualified REIT dividends. While RICs can pass through qualified REIT dividends to their shareholders, investors may in some situations be able to benefit from investing in the same portfolio based solely on a different tax structure.
A seller's secret weapon: the 48-hour clause
This can be used if the buyer and seller enter a contract, but someone then comes along and makes a higher offer. If that happens, the original buyer has 48 hours to come up with the finance for the amount they offered.
