Real estate investment trusts (REITs) are chock full of useful tax benefits that simply aren’t available to many other invest-able companies. Here’s a look at just a few:
The Pass-Through Deduction
Thanks to the tax bill that signed into law in 2017, REITs now boast a new and lucrative tax benefit: the pass-through deduction.
The pass-through deduction allows REIT investors to deduct up to 20% of their dividends. If you’re in the top bracket, the tax bill on your dividends could go from 37% to 29.6%. That means that you’re saving up to $740 annually on $10,000 of REIT dividends. Here’s the simple math:
REIT Dividends: $10,000
20% Deduction: $2,000
Taxable Profits: $8,000
Tax Rate: 37%
Tax Bill BEFORE the 20% Deduction: $3,700
Tax Bill AFTER the 20% Deduction: $2,960
No Double Taxation
Real estate investment trusts, like many companies, distribute earnings to investors in the form of dividends. Unlike many companies however, REITs are not taxed at the corporate level. That means REITs avoid the dreaded “double-taxation” of corporate tax AND personal income tax. Instead, REITs are sheltered from corporate tax so their investors are only taxed once. This is a major reason income investors value REITs over many other dividend-paying companies. More for investors, less for Uncle Sam.
Another gift the tax code has bestowed upon real estate investors is the concept of depreciation. As it relates to REITs, depreciation basically serves as a tax deferral mechanism. The greater the amount of depreciation expense, the more likely it is that the taxable portion of the REIT dividends will decrease.
Depreciation works to effectively reclassify certain dividends from “ordinary income” to “return of capital.” Minimizing “ordinary income” dividends means minimizing the amount of dividend income that is taxed at the personal rate, while maximizing the amount of income that is taxed at a 25% rate.
The 90% Rule
Historically, REITs have been given special tax treatment as a carrot to everyday investors seeking access to a diversified portfolio of real estate without the large capital investment required to actually acquire such a portfolio. In return, the tax code holds REITs to certain standards. One such standard is the 90% rule, which requires REITs to pay out at least 90% of its earnings as dividends.
The 90% rule was created to encourage REITs to fulfill the original goal of allowing everyday investors to enjoy passive income from a diversified portfolio of real estate. The 90% rule is a check on executive management which may seek to reinvest earnings rather than distributing them directly to shareholders.
The U.S. government has used the tax code to encourage investors to participate in real estate gains since the creation of real estate investment trusts in 1960. As was the case in the 2017 Tax Cuts and Jobs Act, more tax benefits continue to emerge for REIT investors with each new draft of the tax code. So the next time you’re with your tax advisor, ask how investing in a REIT can get you the income you want and the tax breaks you deserve.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors.
Eliot Bencuya is the co-founder and CEO of Streitwise. Eliot has extensive experience identifying, underwriting, and executing value-add real estate investments.
Prior to forming Streitwise, he was a Vice President of Acquisitions for Canyon Capital Realty Advisors and the Canyon-Johnson Urban Funds, where he was responsible for originating, underwriting, structuring and executing transactions in the Pacific Northwest, Northern California and Midwest regions. Mr. Bencuya also held positions at Sovereign Investment Company (a subsidiary of the Marcus and Millichap Company) and the investment banking division of Merrill Lynch & Co. He holds a Bachelor of Arts degree in Economics and International Studies from Yale University, and a Masters of Business Administration degree from the Haas School of Business at the University of California, Berkeley. Mr. Bencuya is a member of ULI.