Quick Answer
A REIT is a trust or corporation that owns, operates, or finances income-producing real estate, giving everyday investors access to large-scale real estate portfolios. It must distribute at least 90% of its taxable income as dividends to avoid corporate-level taxation. Those dividends are taxed as ordinary income, not the lower qualified dividend rate.
Moving from Direct Participation Programs (DPPs) to REITs, you'll see a similar theme (tax-advantaged real estate investing) but with a very different structure. REITs make real estate accessible to everyday investors without requiring them to buy, manage, or finance properties directly.
What Is a REIT?
- A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate
- Structured as a trust or corporation (not a partnership like most DPPs)
- Created by Congress in 1960 to give individual investors access to large-scale, diversified real estate portfolios
The 90% Distribution Rule
The defining requirement for REITs:
- A REIT must distribute at least 90% of its taxable income to shareholders as dividends
- In exchange for meeting this requirement, the REIT avoids corporate-level taxation (no double taxation)
REIT Dividends vs. Stock Dividends
This is a key distinction for the exam:
| Feature | REIT Dividends | Regular Stock Dividends |
|---|---|---|
| Tax rate | Ordinary income rates | Qualified dividend rates (lower) |
| Why | No entity-level tax on distributed income (dividends-paid deduction) | Corporate earnings already taxed |
| Entity-level tax | None (if 90% distributed) | Yes (corporate tax paid first) |
- REIT dividends are taxed as ordinary income (not qualified dividends)
- Some portion of distributions may be classified as return of capital (tax-deferred, reduces cost basis)
Exam Tip: Gotchas
REIT dividends are taxed at ordinary income rates, NOT the lower qualified dividend rate. This is because REITs don't pay corporate tax; the trade-off for avoiding double taxation is that shareholders pay their full income tax rate on distributions.
Now let's look at the three types of REITs and what they invest in.
What Should You Check on Exam Day?
- Can you explain why REIT dividends are taxed as ordinary income instead of the lower qualified dividend rate?
- Do you know the minimum percentage of taxable income a REIT must distribute to shareholders?
- Can you state why a REIT avoids corporate-level taxation when it meets the 90% distribution rule?
- Do you know how a REIT's legal structure differs from a DPP's partnership structure?
- Can you explain when Congress created REITs and why?