The REIT Tax Advantage

For the past several decades, Real Estate Investment Trusts (REITs) have offered investors high returns and low taxation. But the advantages once enjoyed by REIT investors may become a thing of the past. Congress recently announced that as part of its comprehensive review of the federal tax code to close loopholes and boost economic growth, it will closely analyze the rules concerning REITs to determine whether a revision is in order.¹

What Is An REIT?

The federal tax code defines an REIT as “any corporation, trust or association that acts as an investment agent specializing in real estate and real estate mortgages.”² REITs were created by Congress and signed into law by President Dwight D. Eisenhower in 1960 for the purpose of giving investors the opportunity to invest in large-scale, diversified portfolios of income-producing real estate.³

Today, REITs are generally companies that own and operate pools of real estate properties and mortgages.⁴ Properties owned by an REIT can be commercial or residential in nature. The pools generate income through the renting, leasing, and selling of real estate.⁵ REITs can be publicly or privately held corporations and are classified into one of three categories: equity, mortgage, or hybrid.⁶

How REIT’s Lower Business Taxes

REIT’s are attractive to investors because of high yields and because of tax advantages. Tax advantages exist with REIT’s because their structure essentially eliminates an entire tax base. To qualify as a REIT, the tax code requires that the REIT pay out at least 90% of its taxable income to its unit holders⁷ annually.⁸ The distributions issued by a REIT are deductible on a corporate level, leaving a trust with a minimal, if not non-existent, tax burden.⁹ Distributions made to the unit holders of a REIT are, however, taxed at the personal level.¹⁰ The main distinguishing feature between an REIT and a corporation is the REIT’s ability to reduce or eliminate the corporate tax it pays. Taxation of corporations are different from that of a REIT as corporate profits are essentially taxes twice, once at the corporate level before a dividend is made and then again at the personal level at the time the dividend is made to its shareholder.¹¹

Conclusion

Industry officials and analysts agree that it is unlikely that any substantial changes will be made to the exemptions available to REITs under the tax code. The main reason for this is that it is believed that the exemptions do not result in a major loss of revenue to the U.S. Treasury.¹² REIT distributions to unit holders are taxed at a rate of almost 40% as compared to the 20% capital gains tax rate assessed to corporate dividends made to shareholders.¹³ According to the National Association of Real Estate Investment Trusts, REITs paid approximately $29 billion in dividends to unit holders in 2012.¹⁴ It is argued that if REITs lost the tax exemptions they currently enjoy and dividends were assessed at the same lower tax rate as other corporations, the gains from removing the exemptions would be offset by the lower tax rate on dividends.¹⁵ Thus, it is expected that REITs will, for the foreseeable future, continue to operate in the same manner as they do today.

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1. http://online.wsj.com/article/SB10001424127887323551004578441260298575162.html; CCH 2008 U.S. Master Tax Guide, paragr. 2326, page 681
2. 26 USC § 856(a)
3. 26 USC § 856; see also https://en.wikipedia.org/wiki/Real_estate_investment_trust
4. http://www.investopedia.com/articles/03/013103.asp
5. 26 USC § 856
6. Id.
7. ie. shareholders
8. 26 USC § 857(a); “Real Estate Investment Trusts (REITs)”. U.S. Securities and Exchange Commission. Retrieved 15 July 2013; http://www.sec.gov/answers/reits.htm
9. 26 USC § 857(b); see also http://www.investopedia.com/articles/03/013103.asp
10. Id.
11. http://www.investopedia.com/articles/03/013103.asp
12. http://online.wsj.com/article/SB10001424127887323551004578441260298575162.html
13. Id.
14. Id.
15. Id.