Most dividends are taxed at ordinary income tax rates (10%-37% depending on your income), but you may be able to claim a 20% qualified business income deduction. Some dividends may be subject to capital gains. Capital gains on REIT dividends are always taxed at long term capital gains rates. Let’s walk through everything you need to know about REITs, how they’re taxed, and how to set yourself up for success when investing in a REIT that pays dividends.
How REITs Make Money And Pay Dividends
When you invest in an REIT, you’re investing in a real estate firm managing commercial or residential properties, such as a shopping mall or apartment complex. Some REITs come with high returns and dividends, but they may also be considered riskier investments. This passive investing method is often popular when real estate markets boom, but it’s important to understand the tax structure before committing to this investment option. There are three types of REITs: In all three, investors receive regular dividends—profit sharing payments from the real estate firms paid monthly, quarterly, or annually. To qualify as a REIT, the company must have at least 90% of its taxable income distributed to shareholders annually, in the form of dividends. The REIT can then deduct all of those dividends that it paid to shareholders from its corporate taxable income. This means that most REITs pay out at least 100% of their taxable income to shareholders. This makes it likely that REITs pay no corporate taxes since those earnings are passed through to shareholders in the form of dividends.
How Are REIT Dividends Taxed For Investors?
As an investor in a REIT, this taxation setup offers you the advantage of only paying taxes on dividends and capital gains once. Most dividends are taxed at your ordinary income tax rate. When paying taxes on REITs, you’ll receive Form 1099-DIV from any REITs you’re invested in during tax season. This form will have a breakdown of dividends received that you can plug into any tax software service or send to your tax professional. This breakdown will include regular income distributions (taxed at your ordinary income tax rate) as well as any capital gains earnings (taxed at a capital gains tax rate).
Ordinary Income Distributions
For dividends categorized as ordinary income, the rate at which you are taxed will vary based on your income and tax bracket. For example, if your taxable income was $50,000 in 2022, you’d be taxed at a rate of 22% for ordinary income distributions paid that year. For example, let’s say you’re in the 22% tax bracket. You have 100 shares in Company ABC REIT and the dividends you receive that are categorized as ordinary income distributions are $2 per share, for a total of $200 (100 x 2 = 200). With the 20% qualified business income deduction, you’d only pay taxes on $160 of that ordinary income distribution ($200 x 20% = $40, $200 - $40 = $160).
Capital Gains Earnings
If the REIT makes a profit from selling a property and distributes that as a dividend, you would be subject to capital gains tax on that dividend. Long-term capital gains tax rates range from 0% to 20%. The capital gains tax rate you pay will vary depending on your income. For example, if your taxable income was between $41,675 to $459,750 in 2022, your capital gains tax rate would be 15%.
Return of Capital
You may also see your REIT dividends categorized as return of capital. This means the REIT is basically giving you back some of the money you invested. You won’t pay taxes on these dividends now, but they reduce your cost basis, and you may have a potentially larger capital gains tax to pay later if/when you sell your REIT shares.
How To Invest in REITs
If you’re interested in investing in REITs, you can do so through a traditional or online broker. A few examples of fund REITs include:
Vanguard REIT ETF (VNQ)Fidelity Real Estate Index Fund (FSRNX)S&P Global REIT (SREITGUP)
You can also invest in REITs directly. For example, these REITs are available for direct investments:
Brandywine Realty Trust (BDN)Innovative Industrial Properties (IIPR)Hannon Armstrong Sustainable Infrastructure Capital (HASI)Safehold (SAFE)Uniti Group (UNIT)Annaly Capital Management (NLY)
The Bottom Line
Before investing in REITs, it’s important to understand how dividends are taxed. With a REIT, you’ll often receive dividends throughout the year, which you’ll need to pay taxes on. The good news is you’ll be sent a breakdown of the income you’ve earned through any dividend distributions you took as well as capital gains, making it easy to file with your tax return. You’ll also likely receive a 20% qualified business income deduction on the part of the dividends that are categorized as ordinary income, which will help you save a little. Work with an accountant to better understand exactly how much you’ll pay in taxes when you invest in a REIT.
