Key Takeaways
- REITs invest in real estate and are usually publicly traded.
- Equity REITs earn rents; mortgage REITs earn interest.
- REITs must meet asset, income, distribution, and ownership tests.
- REITs pass through income but not losses.
- Dividends are generally taxed as ordinary income.
Last updated: January 2026
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
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
| Revenue Sources | Tax Treatment |
|---|---|
| Rental income | Ordinary income |
| Property sales | Capital gains |
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)
| Revenue Sources | Risks |
|---|---|
| Interest income | Interest rate risk |
| Trading gains | Credit risk |
3. Hybrid REITs
- Combine strategies of both equity and mortgage REITs
- Own properties AND invest in mortgages
- Offer diversification within real estate
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)
REIT vs. DPP Comparison
| Feature | REIT | DPP (Limited Partnership) |
|---|---|---|
| Liquidity | High (publicly traded) | Low (no secondary market) |
| Minimum investment | Low (price of one share) | High (often $5,000+) |
| Management | Professional | General partner |
| Liability | Limited to investment | Limited (but recourse debt risk) |
| Pass-through losses | No (cannot pass through losses) | Yes |
| Tax advantages | Dividends only | Depreciation, depletion, IDCs |
Key Distinction
- REITs: Can pass through income but cannot pass through losses
- DPPs: Can pass through both income and losses
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.