How to File Form 1120-REIT for Real Estate Investment Trusts

Real Estate Investment Trusts (REITs) must meet specific tax requirements to maintain their favorable status with the IRS. A key obligation is filing Form 1120-REIT, which reports income, deductions, and other financial details. Properly completing this form ensures compliance and allows REITs to take advantage of tax benefits, such as the dividends paid deduction.

Filing Criteria

To file Form 1120-REIT, a company must qualify as a Real Estate Investment Trust under IRS regulations. This requires meeting income, asset, and shareholder distribution requirements outlined in Internal Revenue Code (IRC) Section 856. At least 75% of a REIT’s gross income must come from real estate-related sources, such as rental income or interest on mortgages. Additionally, at least 75% of total assets must be invested in real estate, cash, or government securities at the end of each quarter.

A REIT must also meet ownership requirements. It must have at least 100 shareholders by the beginning of its second taxable year and cannot be closely held, meaning no more than 50% of its shares can be owned by five or fewer individuals. These rules prevent REITs from operating as private investment vehicles while benefiting from tax advantages.

Form 1120-REIT follows the standard corporate tax return schedule, with returns due by the 15th day of the fourth month after the tax year ends. For calendar-year REITs, this means an April 15 deadline. Extensions are available by filing Form 7004, granting an additional six months to submit the return. However, any taxes owed must be paid by the original due date to avoid penalties and interest.

Dividends Paid Deduction

A major tax advantage for REITs is the ability to deduct dividends paid to shareholders, reducing taxable income at the corporate level. Unlike traditional corporations, which face double taxation—once on earnings and again when dividends are distributed—REITs avoid this by distributing most of their income to investors.

To qualify for this deduction, payments must be classified as dividends under the IRC and paid in cash or property. Stock dividends generally do not qualify unless they meet special conditions under IRC Section 305. Dividends declared in the last three months of the tax year and paid by January 31 of the following year can be treated as if they were paid in the prior year, providing flexibility in managing taxable income.

Certain distributions may not be fully deductible if they exceed the REIT’s earnings and profits. In such cases, the excess is considered a return of capital rather than a taxable dividend. This affects both the REIT’s ability to claim the deduction and the tax treatment for investors, who may see a portion of their distributions reduce their cost basis rather than being taxed as ordinary income.

Elements of the Return

Form 1120-REIT requires detailed reporting of a REIT’s income, deductions, and shareholder distributions. Each section determines taxable income and ensures compliance with IRS regulations. Properly completing these schedules is essential for maintaining REIT status and avoiding unnecessary tax liabilities.

Income Schedules

A REIT’s income primarily comes from real estate-related activities, and Form 1120-REIT requires a breakdown of these revenue sources. The return includes sections for rental income, interest from mortgages, capital gains from property sales, and other qualifying earnings. Rental income is reported net of tenant reimbursements, while mortgage interest must be separated from other interest income to ensure compliance with the 75% gross income test under IRC Section 856(c)(3).

Capital gains are categorized as short-term or long-term, as different tax treatments apply. Long-term gains, typically from properties held for more than a year, may be subject to preferential tax rates when distributed to shareholders. Additionally, REITs must report non-qualifying income, such as service fees or sales of non-real estate assets, which could impact their tax-exempt status if they exceed allowable thresholds. Proper classification of income ensures accurate tax calculations and helps avoid penalties.

Deduction Schedules

Beyond the dividends paid deduction, REITs can claim other deductions to reduce taxable income. Operating expenses, such as property management fees, maintenance costs, and legal expenses, are deductible under IRC Section 162. Depreciation and amortization, reported on Schedule M-3, allow REITs to account for the gradual loss of value in real estate assets over time under the Modified Accelerated Cost Recovery System (MACRS).

Interest expenses on loans used to acquire or improve properties are deductible but must comply with the business interest expense limitation under IRC Section 163(j). This rule generally caps interest deductions at 30% of adjusted taxable income, though REITs often qualify for exceptions due to their real estate focus. Additionally, losses from property sales can offset capital gains, reducing overall tax liability. Proper documentation of these deductions is necessary to support claims in case of an IRS audit.

Shareholder Reporting

REITs must provide shareholders with detailed tax information regarding their distributions. Form 1120-REIT includes sections for reporting dividends paid, including the portion classified as ordinary income, capital gains, or return of capital. This information is crucial for investors, as different types of distributions have varying tax implications. Ordinary dividends are taxed at the investor’s marginal income tax rate, while capital gain distributions may qualify for lower long-term capital gains rates.

In addition to reporting on Form 1120-REIT, REITs must issue Form 1099-DIV to shareholders, detailing the breakdown of their dividends. If a REIT distributes excess earnings beyond its taxable income, a portion of the dividend may be classified as a return of capital, reducing the investor’s cost basis rather than being immediately taxable. Proper classification of distributions ensures compliance with IRS rules and helps investors accurately report their income.

Corporate-Level Taxes

Although REITs can deduct dividends paid to shareholders, they are still taxed on undistributed income, including retained earnings, certain non-qualifying income, and gains that are not fully distributed. The corporate tax rate on undistributed taxable income is 21%, consistent with the federal rate for C corporations under the Tax Cuts and Jobs Act of 2017. If a REIT retains capital gains rather than distributing them, it must pay tax on those gains and provide shareholders with a credit for the tax paid, allowing them to claim a refundable credit on their individual returns.

Excise taxes may also apply if a REIT fails to meet required distribution thresholds. To avoid a 4% excise tax under IRC Section 4981, a REIT must distribute at least 85% of its ordinary income and 95% of its capital gains by year-end. Any shortfall is subject to this penalty, making timely distributions a priority. Additionally, if a REIT earns income from prohibited transactions—such as selling property held primarily for sale rather than for investment—it faces a 100% tax on the gain, reinforcing the need to structure transactions carefully.

Maintaining Records

Accurate record-keeping is necessary for REITs to substantiate income, deductions, and distributions reported on Form 1120-REIT. The IRS requires detailed financial records to support tax filings and ensure compliance with regulations. Proper documentation helps in the event of an audit and facilitates efficient tax planning and financial reporting.

Financial records should include lease agreements, mortgage contracts, and property acquisition documents to verify income sources. Expense records, such as invoices for property management fees, legal costs, and interest payments, should be retained to support deductions. Dividend payment records, including board resolutions authorizing distributions and shareholder payment confirmations, are necessary to substantiate the dividends paid deduction. Additionally, REITs must track earnings and profits calculations to determine the proper classification of distributions, ensuring that shareholders receive accurate tax reporting on Form 1099-DIV.