Table of Contents
Real Estate Investment Trusts (REITs) offer investors a way to earn income from real estate without owning property directly. This article summarizes key concepts related to REIT investing, including advantages, disadvantages, taxation, and how the Qualified Business Income (QBI) deduction can enhance after-tax returns.
Advantages of REITs
- Monthly or Quarterly Income: REITs are required to distribute at least 90% of taxable income to shareholders, making them a consistent income source.
- Liquidity: Publicly traded REITs can be bought or sold like stocks.
- Diversification: Investors gain exposure to multiple sectors of real estate.
- Professional Management: Assets are managed by real estate professionals.
- Accessibility: Low investment minimums allow broad investor participation.
Disadvantages of REITs
- Taxable Dividends: Most REIT dividends are taxed at ordinary income rates.
- Interest Rate Sensitivity: Rising interest rates can pressure REIT share prices.
- Limited Growth: High payout requirements limit capital reinvestment.
- Market Volatility: Public REITs are subject to stock market fluctuations.
- Sector Risk: REITs focused on a single sector may be vulnerable to downturns.
Marginal Ordinary Income Tax Rate
Your marginal tax rate is the rate applied to your last dollar of taxable income. For example, if you earn $60,000 and fall into the 22% tax bracket, your marginal rate is 22%. Only the income in that bracket is taxed at 22%; income in lower brackets is taxed at lower rates. REIT dividends, unless classified otherwise, are taxed at this marginal ordinary rate.
Qualified Business Income (QBI) Deduction for REIT Dividends
The QBI deduction (Section 199A) allows investors to deduct up to 20% of qualified REIT dividends, even if they do not own a business. This applies to ordinary dividends only—not capital gains or return of capital.
Example:
If you receive $5,000 in REIT ordinary dividends: - Deductible amount: $5,000 × 20% = $1,000 - Taxable portion: $5,000 − $1,000 = $4,000
There are no income phaseouts or business-type restrictions for the REIT portion of this deduction, making it one of the most accessible features of the tax code for individual investors.
Conclusion
REITs offer a balance of income, liquidity, and diversification but come with tax complexity and market sensitivity. Understanding your marginal tax rate and using the QBI deduction can significantly improve after-tax returns, especially in taxable accounts. To further reduce tax drag, see Harvesting Losses for Tax Free Income. Always consult a tax advisor to assess how REITs fit into your investment and tax strategy.