Real estate investment trust (REIT) taxation
Real estate investment trusts are companies that hold and manage earning real estate.
They replace direct investments and allow even investors with limited personal capital to enjoy yields from earning real estate.
In order to be considered an REIT, a company must meet certain regulatory criteria determined by the US tax code, including:
- 75% of income originating in real estate (rent, mortgage interest, capital gains etc.);
- 75% of assets invested in real estate;
- 95% of income originating in interest or dividend real estate;
- At least 100 shareholders, with less than 50% held by 5 persons or less.
In addition to these criteria, a company must divide approximately 90% of its income in a given tax year among shareholders in order to enjoy REIT taxation benefits. Once these demands are met, tax duty is transferred to the shareholders.
An REIT can be categorized by three sources of income:
- Dividend – taxed under regular progressive tax rates, unless the dividend falls under the definition of preferred tax rates.
- Capital gains distribution – shall always be taxed according to long-term capital gains tax rates, regardless of how long the property has been in possession.
- Return on capital – no tax event. The return will lower the shareholder’s basis, creating greater profits on future sales.
Upon sale, the investor will be subject to capital gains tax rates according to the duration of possession.