REIT
A REIT is an entity (publicly traded or privately held) owning income-producing real estate, qualified under IRC §856 by holding 75%+ of assets in real estate, deriving 75%+ of gross income from real estate, and distributing 90%+ of taxable income annually to shareholders. Distributions to shareholders carry mixed tax character — ordinary dividend, return of capital, capital-gain distribution — typically reported on the year-end 1099-DIV.
REITs are the dominant retail-accessible real estate exposure. Public REITs trade on exchanges like equities; private REITs (interval funds, non-listed REITs) require accredited-investor status and have limited liquidity. Both share the §856 structural requirements: 75% real-estate assets, 75% real-estate-source gross income, 90% distribution requirement. The 90% distribution requirement means REITs typically pay high yields (4–7% range) but retain little earnings for reinvestment — leading to frequent secondary equity issuance for growth.
Distribution tax character is the unique complication. A typical REIT distribution might break down as 65% ordinary dividend, 25% return of capital, 10% capital-gain distribution. The ordinary-dividend portion is taxed at ordinary income rates (NOT the qualified-dividend preferential rates) because REIT distributions don't pass the §1(h)(11) qualified-dividend test. Return of capital reduces the holder's basis (no current tax until basis hits zero). The capital-gain distribution portion is taxed at long-term capital-gain rates regardless of the holder's tenure.
TCJA §199A added a 20% Qualified Business Income deduction for REIT ordinary dividends — partially offsetting the disadvantage of non-qualified-dividend treatment. A high-bracket taxpayer receiving $10,000 of REIT ordinary dividends previously paid 37% federal = $3,700; under §199A, the $10,000 qualifies for the 20% deduction = effective $8,000 taxable, $2,960 federal tax. The deduction is reported separately on Form 1099-DIV (box 5) and flows through to Schedule A or Form 8995. Most retail REIT investors are unaware of the deduction; sophisticated tax software auto-applies it.
| Public REIT | Direct Real Estate | |
|---|---|---|
| Liquidity | Daily, exchange-traded | Months — illiquid |
| Minimum investment | $0 (fractional) | Down payment + transaction costs |
| Tax form | 1099-DIV (mixed character) | Schedule E (rental income, depreciation) |
| Depreciation pass-through | No (REIT level only) | Yes (to owner) |
| 1031 exchange | No | Yes |
| Step-up at death | Yes (on shares) | Yes (on property) |
Synthetic REIT positions need realistic distribution-character splits per quarterly distribution: ordinary dividend %, return of capital %, capital-gain distribution %, §199A-eligible amount. Year-end 1099-DIV aggregation should match per-distribution data. Retail households often hold multiple REITs (broad REIT ETF + healthcare REIT + storage REIT); each has different distribution mix and the aggregate matters.
Common pitfalls
- Treating REIT distributions as qualified dividends — they almost always are NOT (don't qualify under §1(h)(11)).
- Aggregating REIT distributions without preserving tax character — each component has different downstream tax treatment.
- Forgetting the §199A QBI deduction on REIT ordinary dividends — TCJA-era benefit that survives the income-bracket phaseouts that limit the deduction for other QBI.
- Ignoring return-of-capital basis adjustments — accumulating RoC distributions reduce basis to zero over many years for high-distribution REITs, after which further RoC becomes capital gain.
Examples
Holder owns 1,000 shares O. Annual distributions: $3.16/share total = $3,160. Year-end 1099-DIV breakdown (representative): box 1a $2,054 (ordinary dividend, 65%); box 5 $2,054 (§199A-eligible portion, same as box 1a); box 3 $948 (return of capital, 30%); box 2a $158 (capital-gain distribution, 5%). Cash received: $3,160. Taxable income (before §199A): $2,212. With §199A 20% deduction on $2,054: effective taxable $1,801. Basis reduction: $948.