Real estate investment trusts (REITs) are a popular way for investors to invest in the real estate market without owning and managing properties themselves. REITs are companies that own and operate income-generating real estate assets, such as shopping malls, office buildings, and apartments. One of the benefits of investing in REITs is the tax advantages they offer. In this blog post, we will discuss the tax advantages and disadvantages of REITs.
Tax Advantages of REITs:
- Dividend Income: REITs are required by law to distribute at least 90% of their taxable income to their shareholders in the form of dividends. These dividends are typically taxed at the lower long-term capital gains rate, which is currently 20% for high-income earners. This means that investors in REITs can benefit from a lower tax rate on their dividend income compared to other types of stocks that may pay out ordinary dividends, which are taxed at the higher ordinary income tax rate.
- Depreciation Deductions: Like other real estate investments, REITs are eligible for depreciation deductions. Depreciation is a tax deduction that allows investors to deduct the cost of the property over a period of time. This can help reduce the taxable income generated by the REIT, which in turn can lower the amount of taxes owed by investors.
- 1031 Exchange: REITs can be used in a 1031 exchange, which allows investors to defer paying taxes on capital gains when they sell one property and buy another. By exchanging their investment in one REIT for another REIT, investors can defer paying capital gains taxes until they sell their investment in the new REIT.
Tax Disadvantages of REITs:
- Income Taxes: REITs are subject to income taxes at the corporate level. This means that the income generated by the REIT is first subject to corporate income taxes before it can be distributed to shareholders. This can reduce the amount of income available to distribute as dividends, which can affect the yield of the investment.
- Capital Gains Taxes: When investors sell their shares in a REIT, they are subject to capital gains taxes on any profit they make from the sale. This includes any gains resulting from the increase in share price as well as any gains resulting from the distribution of dividends.
- Loss of Tax Benefits: If a REIT is not able to meet the requirements to qualify as a REIT, it can lose its tax benefits. For example, if the REIT fails to distribute at least 90% of its taxable income to shareholders or fails to meet other requirements under the tax code, it may lose its REIT status and become subject to higher corporate income taxes.
In conclusion, REITs offer tax advantages and disadvantages for investors. On one hand, REITs can provide investors with a lower tax rate on dividend income and depreciation deductions. On the other hand, REITs are subject to corporate income taxes, capital gains taxes, and the risk of losing their tax benefits if they fail to meet certain requirements. It is important for investors to consider both the tax advantages and disadvantages of REITs when making investment decisions. As always, it is recommended that investors consult with a tax professional to determine how REIT investments fit into their overall tax planning strategies.
Meet Krishnaprasath Krishnamoorthy, a finance content writer with a wealth of knowledge and experience in the insurance, mortgage, taxation, law, and real estate industries.