REITs carry two tax advantages ordinary stocks don’t. A real estate investment trust that pays out at least 90% of its taxable income owes no federal corporate tax on the distributed portion, so rental profits, mortgage interest, and property sale gains reach shareholders without the 21% haircut a regular C corporation would take first. On top of that, individual investors can deduct 23% of their qualified REIT dividends under Section 199A, which pulls the effective federal rate well below what ordinary wages would face.
No Corporate-Level Tax on Distributed Income
Regular corporations pay a flat 21% federal tax on profits before any dividend reaches you.1Internal Revenue Service. Publication 542, Corporations You then owe tax again on your personal return. That is the double-taxation problem baked into ordinary corporate stock.
REITs skip the first layer. Under Internal Revenue Code Section 857, a REIT deducts the dividends it pays to shareholders from its taxable income.2Office of the Law Revision Counsel. 26 USC 857 – Taxation of Real Estate Investment Trusts and Their Beneficiaries Because most REITs push out nearly all their earnings, this dividends-paid deduction usually zeroes out the entity’s tax bill. Rental income, mortgage interest, and property sale profits flow through to investors without a 21% cut at the entity level first. Compounded over decades, the difference between paying corporate tax and skipping it entirely is significant.
The 23% Section 199A Deduction on Qualified REIT Dividends
Section 199A of the Internal Revenue Code lets you deduct a percentage of your qualified REIT dividends before calculating what you owe.3Internal Revenue Service. Qualified Business Income Deduction The deduction started at 20% under the Tax Cuts and Jobs Act of 2017 and was scheduled to expire after 2025. The One Big Beautiful Bill Act, signed in 2025, made it permanent and raised it to 23%.
The math is direct. An investor in the top 37% federal bracket who collects $10,000 in qualified REIT dividends deducts $2,300 and pays tax on $7,700. That drops the effective federal rate on those dividends to roughly 28.5%. Investors in lower brackets see a proportional benefit. The deduction is available whether you itemize or take the standard deduction, so nearly every REIT shareholder qualifies.
One rule catches active traders. You must hold the REIT shares more than 45 days within the 91-day window around the ex-dividend date to qualify.4eCFR. 26 CFR 1.199A-3 – Qualified Business Income, Qualified REIT Dividends, and Qualified PTP Income Buy-and-hold investors clear this without thinking about it. Anyone trading around dividend dates should track timing carefully, because dividends on shares held 45 days or fewer don’t qualify and are taxed at the full ordinary rate.
How Each Type of REIT Distribution Is Taxed
Not every dollar a REIT sends you gets the same treatment. The character of each distribution depends on where the money came from, and your annual 1099-DIV breaks it down into three main categories.
Ordinary Dividends
Most REIT distributions land here. These come from rental income and operating profits and are taxed at your regular federal income tax rate, up to 37%. The Section 199A deduction applies to this portion. Your 1099-DIV reports ordinary dividends in Box 1a, and the amount eligible for the 199A deduction appears separately in Box 5.5Internal Revenue Service. Instructions for Form 1099-DIV (Rev. January 2024)
Capital Gain Distributions
When the REIT sells a property at a profit, the gains passed to shareholders are treated as long-term capital gains no matter how long you personally held the shares. The maximum federal rate is 20%.6Internal Revenue Service. Topic No. 409, Capital Gains and Losses These amounts show up in Box 2a of your 1099-DIV.
A portion may be classified as unrecaptured Section 1250 gain, which represents depreciation the REIT previously claimed. That slice is taxed at a maximum of 25% rather than 20%. The distinction matters most for REITs that actively buy and sell properties, since depreciation recapture can be a large share of the distribution in heavy sale years.
Return of Capital
Return of capital distributions aren’t taxed when received. They happen when a REIT’s cash flow exceeds its taxable income, often because depreciation reduces reported profit without reducing actual cash. Instead of triggering immediate tax, a return of capital reduces your cost basis in the shares.
The benefit is deferral. You owe nothing until you eventually sell, at which point the lower basis produces a larger taxable gain. If basis reaches zero, further return of capital distributions start being taxed as capital gains. For long-term holders, this deferral is meaningful because you keep earning returns on money that would otherwise have gone to the IRS.
The 3.8% Net Investment Income Tax
High earners face an additional 3.8% surtax on net investment income, including REIT dividends of every type. It applies once modified adjusted gross income passes $200,000 for single filers or $250,000 for married couples filing jointly.7Internal Revenue Service. Net Investment Income Tax The surtax stacks on whatever rate already applies, so the true top effective rate on ordinary REIT dividends is closer to 32.3% after both the 199A deduction and the surtax. Still lower than the combined rate the same income would face inside a standard C corporation.
Why Retirement Accounts Are a Good Home for REITs
Because most REIT dividends are taxed as ordinary income rather than at the qualified dividend rate, tax-advantaged accounts are an especially efficient place to hold them. In a traditional IRA, dividends accumulate tax-deferred until withdrawal. In a Roth IRA, qualified withdrawals come out entirely tax-free. Either way, you skip the annual tax drag that eats into returns in a taxable brokerage account.
Investors sometimes worry about unrelated business taxable income. Some investments held in IRAs, particularly master limited partnerships, generate UBTI and trigger tax even inside a retirement account. Ordinary REIT dividends generally do not create UBTI. The issue can surface in rare situations involving leveraged REIT structures, but for the vast majority of publicly traded REITs it isn’t a practical concern.
The Rules That Keep These Advantages Alive
The tax breaks above exist only because REITs follow strict rules that keep them functioning as passive real estate investment vehicles. If a REIT fails these tests, it can lose its special tax status entirely and owe corporate tax on all its income. You rarely have to police this yourself, but the rules explain why REITs behave the way they do.
The 90% Distribution Requirement
A REIT must distribute at least 90% of its taxable income to shareholders each year. This isn’t optional. If the REIT falls short, the favorable provisions of the tax code stop applying for that year.2Office of the Law Revision Counsel. 26 USC 857 – Taxation of Real Estate Investment Trusts and Their Beneficiaries The rule is why REITs consistently pay high dividends compared to other stocks. They are legally required to push most of their earnings out.
Even a REIT clearing the 90% bar can face a 4% excise tax if it doesn’t distribute enough within the calendar year. The threshold to avoid the excise tax is higher: at least 85% of ordinary income plus 95% of capital gain net income for that year.8Office of the Law Revision Counsel. 26 USC 4981 – Excise Tax on Undistributed Income of Real Estate Investment Trusts Shortfalls trigger the excise tax on the underdistributed amount rather than loss of REIT status.
Asset and Income Tests
At the close of each quarter, at least 75% of a REIT’s total assets must be real estate, cash, or government securities. On the income side, at least 75% of annual gross income must come from real estate sources like rents, mortgage interest, or property sales. A separate test requires at least 95% of gross income to come from those real estate sources plus other passive income like dividends and interest.9Office of the Law Revision Counsel. 26 USC 856 – Definition of Real Estate Investment Trust Publicly traded REITs meet these tests as a matter of normal operations, which is why the tax advantages that pull investors in stay reliably in place year after year.