Money you receive from a REIT is split into three buckets on your Form 1099-DIV, and each bucket is taxed under its own rules. Most of it is ordinary income taxed at your regular federal rate, up to 37% in 2026, though a 20% deduction can shave that down. A smaller slice may be long-term capital gains taxed at 0%, 15%, or 20%. And a third slice, called return of capital, isn’t taxed the year you get it at all — it lowers your cost basis and pushes the tax into the year you sell. That three-way split is the core of how REITs are taxed, and each piece works differently enough to be worth understanding on its own.
Ordinary Dividends: The Biggest Bucket
The largest portion of most REIT distributions is ordinary income, taxed at your marginal federal rate. For 2026, those rates run from 10% to 37%, with the top bracket starting at taxable income above $640,600 for single filers and $768,700 for joint filers.1Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
REIT ordinary dividends do not get the lower rates that apply to “qualified dividends” from most corporate stocks.2Internal Revenue Service. Topic No. 404, Dividends and Other Corporate Distributions The reason is structural: qualified dividend rates exist to offset corporate income tax already paid on the underlying earnings, and a REIT pays little or no corporate tax because it deducts what it distributes.
The 20% Section 199A Deduction
Section 199A lets you deduct up to 20% of your qualified REIT dividends before the tax is calculated.3Office of the Law Revision Counsel. 26 USC 199A – Qualified Business Income The One Big Beautiful Bill Act made this deduction permanent in 2025. If you receive $10,000 in ordinary REIT dividends, $2,000 is shielded and you’re taxed on $8,000. At the top 37% bracket that works out to an effective federal rate of roughly 29.6% on the ordinary portion.
There’s a holding requirement. You have to own the shares for at least 46 days during the 91-day window that begins 45 days before the ex-dividend date.4eCFR. 26 CFR 1.199A-3 – Qualified Business Income, Qualified REIT Dividends Buy right before a dividend and sell right after, and that distribution isn’t eligible. The amount that qualifies for the deduction shows up in Box 5 of your Form 1099-DIV.5Internal Revenue Service. Instructions for Form 1099-DIV
Capital Gain Distributions
When a REIT sells an appreciated property and passes the profit to shareholders, that payment is a capital gain distribution. It is always treated as long-term, no matter how long you’ve held your REIT shares.2Internal Revenue Service. Topic No. 404, Dividends and Other Corporate Distributions The 2026 long-term rates are 0%, 15%, and 20%. For single filers, 0% applies up to $49,450 of taxable income, 15% covers $49,451 to $545,500, and 20% applies above that.6Internal Revenue Service. Topic No. 409, Capital Gains and Losses For married couples filing jointly, the 15% band runs from $98,901 to $613,700, with 20% above.
Report these on line 13 of Schedule D using the number from Box 2a of your 1099-DIV.7Internal Revenue Service. Instructions for Schedule D, Form 1040 Form 8949 is not required for capital gain distributions because the REIT has already done the calculation.
The 25% Unrecaptured Section 1250 Slice
Part of a capital gain distribution may be tagged as “unrecaptured Section 1250 gain.” This represents depreciation the REIT previously deducted on the property it sold. Because those deductions reduced the REIT’s taxable income in earlier years, the IRS claws some of it back by taxing this portion at a maximum rate of 25% instead of the standard long-term rates. The amount is broken out separately on your 1099-DIV and any supplemental statements. Track it. Rolling it in with the rest of your capital gains at the lower rate will leave you underpaid.
Return of Capital: Deferred, Not Forgiven
Sometimes a REIT pays out more cash than it has in current earnings and profits. That excess is classified as a return of capital, and it isn’t taxed the year you receive it. Instead, it reduces your cost basis in the shares. This happens often with REITs because depreciation is a non-cash expense that lowers taxable income while leaving cash available to distribute.
Say you bought shares at $50 and receive a $2 return of capital. Your adjusted basis drops to $48. When you sell, the gain is measured against $48, not $50, so you’ll owe more capital gains tax at that point. The tax isn’t erased, just pushed forward.
If Your Basis Hits Zero
Return of capital distributions can keep coming after your basis reaches zero. Once it does, any additional return of capital is taxed as a capital gain in the year you get it. It’s long-term if you’ve held the shares for more than a year. Keep your own running total of basis adjustments; brokerage statements do not always track them reliably, especially if you’re reinvesting distributions.
The Step-Up at Death
Hold the shares until death and the deferred tax can disappear entirely. Your heirs receive a cost basis equal to the fair market value on your date of death.8Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent If you bought at $50, took $15 in return of capital over the years (basis now $35), and the shares are worth $60 when you die, your heirs’ basis is $60. The years of basis reductions wash away.
The 3.8% Net Investment Income Tax
Higher earners owe an extra 3.8% surtax on net investment income, and that includes REIT ordinary dividends and capital gain distributions. The tax applies to the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds these thresholds:9Internal Revenue Service. Net Investment Income Tax
- Single or head of household: $200,000
- Married filing jointly: $250,000
- Married filing separately: $125,000
These thresholds are set by statute and don’t adjust for inflation, so more taxpayers cross them each year. For someone in the top bracket, the combined federal rate on ordinary REIT dividends after the 199A deduction runs about 33.4% (roughly 29.6% plus 3.8%). Capital gain distributions taxed at 20% climb to 23.8% with the surtax layered on.10Internal Revenue Service. Topic No. 559, Net Investment Income Tax
State Taxes Add More
Federal isn’t the whole bill. Most states with an income tax treat REIT dividends as ordinary income at the state level, with top rates from under 3% to over 13%. A few states have no individual income tax at all. In a high-tax state, a high-bracket investor’s combined rate on REIT ordinary income can top 40% even after the Section 199A deduction.
Should You Hold REITs in an IRA or 401(k)?
Because ordinary REIT dividends are taxed at your full marginal rate rather than the qualified-dividend rate, holding them inside a traditional IRA or 401(k) can make sense. Inside those accounts, dividends and capital gains compound without triggering tax. You pay ordinary income tax when you withdraw. Inside a Roth IRA or Roth 401(k), qualifying withdrawals aren’t taxed at all.
The trade-off: you lose the 20% Section 199A deduction inside a tax-deferred account, because everything coming out of a traditional IRA or 401(k) is ordinary income regardless of what it was inside. Whether the shelter is worth more than the lost deduction depends on your current bracket, your expected retirement bracket, and how long you’ll hold the shares. For higher-bracket investors who expect a lower rate in retirement, the tax-deferred account usually wins.
Reading Your Form 1099-DIV
Every year your REIT distributions land on Form 1099-DIV, and the boxes tell you which bucket each dollar falls into:5Internal Revenue Service. Instructions for Form 1099-DIV
- Box 1a, total ordinary dividends — the full ordinary income figure, including any 199A-eligible portion.
- Box 2a, total capital gain distributions — long-term gains from property sales inside the REIT.
- Box 3, nondividend distributions — return of capital that reduces your basis.
- Box 5, Section 199A dividends — the slice of Box 1a eligible for the 20% deduction.
Box 1a flows to your Form 1040. Box 2a goes on line 13 of Schedule D.7Internal Revenue Service. Instructions for Schedule D, Form 1040 Box 3 doesn’t appear as income anywhere on your return — you subtract it from your cost basis in your own records. If you reinvest distributions or hold the shares for many years, keep that basis tally yourself. Brokerages don’t always adjust it correctly for return of capital, and you’ll need the right number the year you sell.