Approximately 170 million Americans own Real Estate Investment Trusts (REITs). This article explores REITs, how they operate, REIT tax information, and why over half of all Americans invest in them.
What is a REIT?
A real estate investment trust, or REIT, is a company that owns, operates, or finances income-producing real estate. The property includes residential and commercial property, such as shopping malls, hotels, warehouses, apartments, self-storage facilities, resorts, or office buildings.
REITs generally lease the property and collect rental income. Some REITs do not own the property but rather provide financing on real estate deals and collect interest income on the loans.
Requirements to qualify as a real estate investment trust?
To qualify as a REIT the company must satisfy the following requirements:
- Be a corporation, trust, or association taxable as a domestic corporation
- Be managed by a board of directors or trustees
- Have a minimum of 100 shareholders
- Have no more than 50% of its share held by five or fewer individuals
- Invest at least 75% of its total assets in real estate
- Derive at least 75 % of its income from real estate-related sources
- Distribute at least 90% of its taxable income to shareholders as dividends each year
Types of REITs
There are four major REIT types:
- Equity REITs
- Mortgage REITs
- Public non-listed REITs
- Private REITs.
Equity REITs own and operate income-producing real estate, and they represent most publicly traded REITs. Mortgage REITs, or mREITs, provide financing for income-producing real estate by purchasing mortgages, originating mortgages, or mortgage-backed securities. They provide a way to hold an equity investment in the mortgage market coupled with the transparency of publicly traded equities, an advantage not readily available through direct investment in mortgage loans or mortgage-backed securities.
Public non-listed REITs (PNLRs) own, operate, or finance real estate and are subject to the same IRS rules as stock exchange-listed REITs; however, they do not trade on major securities exchanges. They are still registered with the SEC and required to make regular SEC disclosures available through the SEC's EDGAR database. They do not offer the same liquidity that stock exchange-listed REITs can provide.
Private REITs, sometimes called private placement REITs, include real estate funds or companies exempt from SEC registration and not traded on national stock exchanges. They are often sold only to institutional investors such as significant pension funds or accredited investors. They are not subject to the same disclosure requirements as a stock exchange-listed REIT, such as a PNLR.
Owning REIT securities
Investors can own REIT securities directly or through investments in mutual funds or exchange-traded funds (ETFs). The majority of U.S. REITs are traded on the New York Stock Exchange (NYSE) or the NASDAQ. An investor can purchase shares of REITs in the same way they would buy shares of other publicly traded companies. Investing in Private REITs can be more complicated and often limited to institutional and accredited investors.
A REIT can be a great way to invest in real estate without requiring direct ownership or investing a lot of cash. The investment can benefit smaller investors who don’t have the time or expertise to perform the due diligence and manage the investment. Even if the small investor did have the cash, expertise, and time to manage their own property, a REIT could still be attractive because it allows for diversification and professional management.
REIT tax (and how to mitigate negative effects)
A REIT produces ongoing income to investors since they are required to distribute 90% of taxable income to its shareholders as dividends. A negative is that most real estate investment trust dividends are not treated as qualified dividends for tax purposes and are, therefore, subject to the ordinary income tax rates instead of the more favorable capital gains tax rates.
One effective strategy to mitigate the potential negative tax effects of REIT investments is to consider using traditional IRAs or similar retirement funds to invest in REITs. Doing so allows you to take advantage of traditional IRAs that are not subject to immediate taxation on earnings. All distributions from these retirement funds are ordinary income like REIT dividends.
Learn more about real estate investment trusts and other topics with Becker CPE
If you’d like to take a deeper dive into this topic, check out our CPE course, Real Estate Investment Trusts: Taxation Basics. This is just one of Becker’s 1,700 CPE courses to help you meet your state requirements, build your skills, and gain new information in the topics that interest you most!
