What are the restrictions for REITs?
REIT Operating Basic
Even with a challenging market, REITs are considered a staple for many investment portfolios thanks to the 90% rule. As the name implies, this rule stipulates that real estate trusts must distribute 90% of their taxable earnings to existing shareholders.
Derive at least 75% of gross income from rent, interest on mortgages that finance real estate, or real estate sales. Pay a minimum of 90% of their taxable income to their shareholders through dividends. Be a taxable corporation.
For each tax year, the REIT must derive: at least 75 percent of its gross income from real property-related sources; and. at least 95 percent of its gross income from real property-related sources, dividends, interest, securities, and certain mineral royalty income.
The REIT's ownership (which must be proven by transferable shares or by transferable certificates of beneficial interest) must be held by at least 100 shareholders for at least 335 days of a 365-day calendar year (or equivalent thereof for a short tax year) for the second taxable year and beyond.
| Pros | Cons |
|---|---|
| Liquidity | Lack of tax benefits |
| Option to diversify | Market risk |
| Transparent | Low growth prospect |
| Risk-adjusted returns | High maintenance fee |
For Group REITs, the consequences of leaving early apply when the principal company of the group gives notice for the group as a whole to leave the regime within ten years of joining or where an exiting company has been a member of the Group REIT for less than ten years.
How Are REITs Taxed for Ordinary Investors? Most REIT dividends are taxed as ordinary income at the investor's marginal tax rate rather than the lower qualified dividend rate. When an investor sells REIT shares, any appreciation is also subject to capital gains taxes.
Bad REIT Income means (i) the amount of gross income received by the Borrower (directly or indirectly) that would not constitute (A) “rents from real property” as defined in Section 856 of the Internal Revenue Code or (B) interest, dividends, gain from sales or other types of income, in each case, described in Section ...
In many cases, this can take around 10 years to occur. And with publicly traded REITs that fluctuate with the stock market, Jhangiani recommends holding onto them for at least three years.
Why are REITs not a good investment?
Inconsistent, variable returns: REITs can be subject to fluctuations in the real estate market, leading to inconsistent returns. Economic recessions, changes in interest rates, or shifts in property values can all impact the performance of REITs, making their returns variable and sometimes unpredictable.
Holding REITs in retirement plans
If you hold an interest in a REIT as part of a tax-advantaged retirement savings plan, such as an IRA or 401(k), the different types of tax treatment don't really matter. That's because investment returns in such plans are not taxed when earned.
Reinvesting REIT dividends can help retirement savers grow their portfolio's investment, and historically steady REIT dividend income can help retirees meet their living expenses. REIT dividends historically have provided: Wealth Accumulation. Reliable Income Returns.
80-20 Rule: At least 80% of a REIT's asset value must be in completed and income-generating real estate, with the remaining 20% able to be invested in riskier assets such as under construction buildings, equity shares, bonds, cash, or under-construction commercial property.
Publicly-traded REITs offer the advantage of liquidity, since individual investors can sell their shares at any time. Privately-traded REITs don't offer this liquidity, but may offer higher dividends. REIT shares are eligible for a step-up in basis upon death, just like real property investments.
- A REIT is required to invest 75% of its assets in real estate.
- Must derive 75% of the gross income from the real estate itself. It can be rental income, mortgages, or the sale of the property.
- Must pay a minimum of 90% of their taxable income in the form of a shareholder dividend.
However, REITs are not risk-free: they may have highly inconsistent, variable returns, are sensitive to interest rate changes are liable to income taxes may not be liquid, and can be dramatically affected by fees.
REIT bankruptcies have indeed been a rarity since the REIT debacle of the mid-1970s, when high leverage and highly speculative real estate investments resulted in numerous REIT failures.
But some of their allure was lost starting in 2022 when the Federal Reserve began to quickly raise interest rates. Even the least risky bond investments now pay out close to 4 percent, and rising interest rates have hammered the commercial property market that many REITs are invested in.
While they provide a compelling set of benefits, it should be noted that, like any investment, non-traded REITs come with risks, including illiquidity, loss of principal, real estate risks, and more.
What is the 90% REIT rule?
In order to maintain REIT status, a REIT must distribute at least 90% of its taxable income in a tax year. In conjunction with the distribution, a REIT is entitled to a deduction for such dividends paid and therefore REITs will generally distribute at least 100% of its taxable income to avoid entity-level tax.
Getting out of a non-traded real estate investment trust, or REIT, can often be rather difficult and expensive. Once a REIT is closed to new investors, the board of directors of the REIT can suspend the redemption policy.
Typically, REIT dividends are taxed individually as ordinary income, but you can avoid the tax burden if your investment grows within a Roth IRA. Investment earnings are tax-free in a Roth IRA -- including REIT dividends -- so you may end up keeping significantly more of your earnings than you would with a REIT alone.
The ``95 percent income test.'' A REIT must derive at least 95 percent of its gross income from dividends, interest, rents from real property, gains from sales of stock, securities or real property (other than dealer property), and income from foreclosure property.
- AGNC Investment Corp. (NASDAQ: AGNC)
- Realty Income Corp. (NYSE: O)
- Apple Hospitality REIT Inc. (NYSE: APLE)
- Chatham Lodging Trust (NYSE: CLDT)
- EPR Properties (NYSE: EPR)
- LTC Properties Inc. (NYSE: LTC)
- Stag Industrial Inc. (NYSE: STAG)
- ARMOUR Residential REIT Inc. (NYSE: ARR)
