Real Estate Investment Trusts (REITs)

REITs provide a way for investors to invest in real estate without directly owning property. Unlike DPPs, most REITs are publicly traded and liquid.

What is a REIT?

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate. REITs must meet specific requirements to qualify for special tax treatment.

Key Characteristics

• Pooled investment in real estate
• Pass-through taxation (like mutual funds)
• Most are publicly traded on exchanges
• Higher liquidity than DPPs
• Professional management

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Types of REITs

1. Equity REITs

• Own and operate income-producing real estate
• Income from rent payments and property appreciation
• Examples: Office buildings, shopping malls, apartments

2. Mortgage REITs (mREITs)

• Invest in real estate mortgages and mortgage-backed securities
• Income from interest payments on loans
• Do NOT own physical property
• Generally pay higher dividends (but more volatile)

3. Hybrid REITs

• Combine strategies of both equity and mortgage REITs
• Own properties AND invest in mortgages
• Offer diversification within real estate

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REIT Requirements

To qualify as a REIT and receive pass-through tax treatment:

Asset Requirements

• At least 75% of assets must be in real estate, cash, or government securities
• No more than 25% in other securities

Income Requirements

• At least 75% of income must come from real estate sources
• At least 95% of income must come from dividends, interest, and property income

Distribution Requirements

• Must distribute at least 90% of taxable income to shareholders
• Distributions are typically taxed as ordinary income (not qualified dividends)

Ownership Requirements

• Must have at least 100 shareholders
• No more than 50% owned by 5 or fewer individuals (5/50 test)

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REIT vs. DPP Comparison

Key Distinction

• REITs: Can pass through income but cannot pass through losses
• DPPs: Can pass through both income and losses

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REIT Taxation

Dividend Taxation

• REIT dividends are generally taxed as ordinary income
• NOT eligible for qualified dividend tax rates (15%/20%)
• Some portion may be classified as return of capital

Special 199A Deduction

• REIT dividends may qualify for 20% deduction under Section 199A
• Effectively reduces the tax rate on REIT income

Capital Gains

• If REIT distributes capital gains, they're taxed at capital gains rates
• Investor receives 1099-DIV showing breakdown

Exam Tip: REIT Dividends Unlike qualified dividends from stocks, REIT dividends are taxed as ordinary income. This is because REITs don't pay corporate tax, so the dividend tax break doesn't apply.