How Are Dividends From REITs Taxed?

A Real Estate Investment Trust, or REIT, is a company that owns, operates, or finances income-producing real estate. Investing in a REIT allows individuals to invest in a portfolio of real estate assets, similar to investing in other industries through stocks. The distributions, commonly called dividends, that REITs pay to their shareholders have specific tax implications that differ from the dividends paid by standard corporations.

The Three Types of REIT Distributions

A payment from a REIT is often called a single dividend, but for tax purposes, it consists of three components. Each part has a distinct tax treatment, and the combination determines the total tax impact. The REIT specifies the character of the distributions, providing shareholders with the necessary breakdown for tax reporting.

Ordinary Dividends

The largest portion of a REIT distribution is classified as an ordinary dividend, representing the investor’s share of the REIT’s net income from sources like rent. A requirement for a company to maintain its REIT status is distributing at least 90% of its taxable income to shareholders annually. Unlike qualified dividends from many corporations, ordinary REIT dividends are not taxed at lower capital gains rates. They are taxed at the investor’s regular income tax rate, which can be as high as 37%.

Capital Gains Distributions

When a REIT sells a property for a profit and passes that gain to shareholders, it is a capital gain distribution. For the investor, this portion of the dividend is treated as a long-term capital gain if the REIT held the property for more than one year. Long-term capital gains are taxed at preferential rates of 0%, 15%, or 20%, depending on the investor’s taxable income. This component allows investors to benefit from property appreciation at a lower tax cost.

Return of Capital

A return of capital (ROC) occurs when a REIT distributes more cash than its taxable earnings for the year, sometimes due to non-cash expenses like property depreciation. A return of capital is not taxed in the year it is received. Instead, this distribution reduces an investor’s cost basis in their REIT shares. For example, if an investor paid $50 per share and receives a $2 per share ROC, their new cost basis becomes $48. This tax-deferred treatment means taxes are paid later, when the shares are sold, through a potentially larger capital gain.

The Qualified Business Income Deduction for REITs

A tax benefit for REIT investors is the Qualified Business Income (QBI) deduction, which allows eligible taxpayers to deduct up to 20% of their qualified REIT dividends. This deduction directly reduces taxable income, lowering the tax rate on the ordinary income portion of the distributions. For a taxpayer in the highest tax bracket, this can reduce the effective federal tax rate from 37% to 29.6%.

Qualified REIT dividends are the ordinary dividends received from the REIT; capital gain and return of capital portions are not eligible. The 20% deduction is calculated from the total qualified REIT dividends an investor receives. For instance, an investor with $2,000 in qualified REIT dividends may be able to claim a $400 QBI deduction.

The QBI deduction for REIT dividends is not subject to the income-based phase-outs that apply to other business income. However, a taxpayer’s total QBI deduction cannot exceed 20% of their taxable income after subtracting net capital gains. The deduction is available whether a taxpayer itemizes or takes the standard deduction and is set to expire after the 2025 tax year unless extended.

Reporting REIT Dividends on Your Tax Return

Your brokerage firm will provide Form 1099-DIV early in the year following the distributions. This form consolidates all the necessary details and breaks down the total distribution into its various tax categories for accurate reporting.

On Form 1099-DIV, Box 1a shows the total ordinary dividends. Box 2a contains the total capital gain distributions, which are transferred to Schedule D, “Capital Gains and Losses.” Box 3 reports nondividend distributions, which is the return of capital portion. Box 5 lists the qualified REIT dividends used to calculate your QBI deduction.

The ordinary dividends from Box 1a are reported as part of your gross income on Form 1040. The capital gains from Box 2a are combined with other gains or losses on Schedule D. The amount in Box 5 is used to complete Form 8995, or Form 8995-A for more complex situations, for the QBI deduction. The return of capital from Box 3 is not reported as current income; you must use it to adjust the cost basis of your shares and maintain this record.

Special Considerations for REIT Investments

The tax treatment of a REIT can be altered by the type of account it is held in, the investor’s state of residence, and the REIT’s structure.

REITs in Tax-Advantaged Accounts

Holding REITs within a tax-advantaged account like a Traditional IRA, Roth IRA, or 401(k) changes the tax treatment. Inside these accounts, annual dividend distributions do not create a current tax liability, making the specific character of the dividend irrelevant for annual filing. For Traditional IRAs and 401(k)s, taxes are deferred until withdrawal. For Roth IRAs, qualified withdrawals are tax-free, sheltering the ordinary income component from annual taxation.

State and Local Taxation

Investors must also consider state and local income taxes, as REIT dividend income is also taxable at these levels. The rules for taxing this income vary by jurisdiction. Some states follow the federal treatment, while others have their own regulations. Investors should be familiar with the tax laws in their state of residence to ensure compliance.

Publicly Traded vs. Non-Traded REITs

While tax principles are the same, reporting can differ between publicly traded and non-traded REITs. Publicly traded REITs provide a Form 1099-DIV. Non-traded REITs may have more complex structures, resulting in investors receiving a Schedule K-1. This form reports income from partnership interests and can complicate tax preparation.