Section 857 of the Internal Revenue Code governs how a Real Estate Investment Trust and its shareholders are taxed. The mechanism is straightforward in outline: a REIT that distributes at least 90% of its taxable income to shareholders can deduct those dividends and pay little or no corporate-level tax on the distributed portion. The character of the income flows through to shareholders, who pay tax on it at their own rates. Several carve-outs sit on top of this structure, and specific entity-level taxes still apply to income the REIT keeps or earns from disfavored activities.
The Taxable Income Base: REITTI
Everything in Section 857 runs off Real Estate Investment Trust Taxable Income (REITTI). It starts with the REIT’s overall taxable income and then strips out items that follow their own tax path.
The corporate-level deductions in Part VIII of Subchapter B, most importantly the dividends received deduction, are disallowed. The one survivor is the deduction for organizational expenditures under Section 248.1Office of the Law Revision Counsel. 26 USC 857 – Taxation of Real Estate Investment Trusts and Their Beneficiaries Net capital gains are pulled out of the base as well, because they either get distributed as Capital Gain Dividends or retained and taxed at the entity level and then passed through as undistributed capital gains. Excluding them here prevents double counting.
REITTI also strips out three categories of income that carry their own separate entity-level taxes, discussed in the next section. Any tax the REIT pays on those items reduces REITTI, so the distribution requirement is measured against income the REIT has already been taxed on where applicable.
Net operating losses get an adjustment too. A prior-year NOL carried through the current year to a future year under Section 172 is excluded from current-year taxable income for REITTI purposes.2Office of the Law Revision Counsel. 26 USC 172 – Net Operating Loss Deduction That keeps the 90% distribution obligation tied to what the REIT actually earned in the current year rather than to income absorbed by a carryover.
The 90% Distribution Requirement and the Dividends Paid Deduction
A REIT must distribute at least 90% of its REITTI (computed before the dividends paid deduction and excluding net capital gains) to keep its status.1Office of the Law Revision Counsel. 26 USC 857 – Taxation of Real Estate Investment Trusts and Their Beneficiaries Distributions that count are then deducted from taxable income through the Dividends Paid Deduction. A REIT that pays out its full income deducts its full income, and nothing is left at the corporate level.
Falling below the 90% floor costs the REIT its conduit status for the year. Three provisions exist to prevent that outcome when the shortfall is a matter of timing or later adjustment rather than intent.
Spillover Dividends
Final income figures are rarely known on the last day of the fiscal year, so Section 858 gives a grace period. A dividend declared before the return’s due date (including extensions) and paid within 12 months after the close of the taxable year can be treated as paid during the preceding year for DPD purposes.3Office of the Law Revision Counsel. 26 USC 858 – Dividends Paid by Real Estate Investment Trust After Close of Taxable Year The REIT elects the treatment on its return and specifies the amounts. The shareholder includes the dividend in income for the year they actually receive it.
Consent Dividends
A REIT that needs to satisfy the distribution requirement without paying cash can use consent dividends under Section 565. Shareholders holding “consent stock” on the last day of the taxable year file a consent with the REIT’s return agreeing to treat a specified amount as if it had been received as a dividend and reinvested.4Office of the Law Revision Counsel. 26 U.S. Code 565 – Consent Dividends No cash moves, but the amount counts toward the DPD. Foreign shareholders must include payment equal to the withholding tax that would have applied to an actual cash dividend.
Deficiency Dividends
When the IRS adjusts a REIT’s taxable income upward after the fact, Section 860 lets the REIT fix the resulting distribution shortfall retroactively. The REIT distributes property to shareholders within 90 days of the determination and files Form 976 within 120 days of it.5Office of the Law Revision Counsel. 26 USC 860 – Deduction for Deficiency Dividends Doing so preserves conduit status. The procedure is unavailable when the shortfall stems from fraud or willful failure to file a timely return.
Entity-Level Taxes a REIT Still Pays
Meeting the 90% requirement does not mean a REIT owes nothing at the entity level. Section 857 layers on specific taxes aimed at activities and shortfalls the statute discourages.
Prohibited Transactions: 100%
Income from prohibited transactions—sales of property the REIT held primarily for sale to customers, in effect acting as a real estate dealer—is excluded from REITTI and instead hit with a separate 100% tax on the net gain.6Office of the Law Revision Counsel. 26 U.S. Code 857 – Taxation of Real Estate Investment Trusts and Their Beneficiaries Losses from prohibited transactions get no deduction: if the category nets to a loss, an amount equal to that loss is added back into the income calculation. The design makes dealer activity economically punishing.
Foreclosure Property: 21%
Net income from foreclosure property is excluded from REITTI because the REIT pays a separate tax on it at the highest corporate rate under Section 11(b), currently 21%.6Office of the Law Revision Counsel. 26 U.S. Code 857 – Taxation of Real Estate Investment Trusts and Their Beneficiaries
Transactions With a Taxable REIT Subsidiary: 100%
Section 857(b)(7) imposes a 100% tax on redetermined rents, redetermined deductions, excess interest, and redetermined service income arising from transactions between a REIT and its Taxable REIT Subsidiary.6Office of the Law Revision Counsel. 26 U.S. Code 857 – Taxation of Real Estate Investment Trusts and Their Beneficiaries The tax is aimed at REITs that shift income to, or inflate deductions through, a TRS relationship.
The 4% Excise Tax on Undistributed Income
Section 4981 imposes a separate 4% non-deductible excise tax on undistributed calendar-year income. The required distribution equals 85% of ordinary income plus 95% of capital gain net income for the calendar year.7Office of the Law Revision Counsel. 26 USC 4981 – Excise Tax on Undistributed Income of Real Estate Investment Trusts The 4% tax applies to the shortfall between that required amount and what the REIT actually paid out. The “distributed amount” includes dividends paid during the calendar year plus any income the REIT already paid corporate tax on under Section 857.
In practical terms, a REIT can retain up to 15% of ordinary income and 5% of capital gains without owing the excise tax, on top of meeting the annual 90% status requirement. The excise tax is reported on Form 8612, due March 15 of the following year.8Internal Revenue Service. Instructions for Form 8612 An automatic six-month extension is available for filing the return but not for paying the tax.
How Shareholders Are Taxed on REIT Distributions
Shareholders receive Form 1099-DIV each year with distributions split into categories that carry different rates. Because character flows through, ordinary income stays ordinary and capital gains stay capital gains in the shareholder’s hands.
Ordinary Dividends and the Section 199A Deduction
Most REIT distributions are ordinary dividends taxed at the shareholder’s marginal rate, which in 2026 reaches 37% at the top.9Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 REIT ordinary dividends generally do not qualify for the reduced rates that apply to Qualified Dividend Income from regular corporations.
Section 199A softens the impact. Individual taxpayers can deduct up to 20% of qualified REIT dividends, which caps the effective top rate on those dividends at roughly 29.6%.10Internal Revenue Service. Qualified Business Income Deduction The One Big Beautiful Bill Act made the deduction permanent starting in 2026 and widened the phase-in ranges to $75,000 for single filers and $150,000 for joint filers, letting more taxpayers claim a partial deduction before income-based limitations fully apply.
Capital Gain Dividends
When a REIT sells an asset at a long-term capital gain, it can designate part of its distribution as a Capital Gain Dividend. The gain keeps its long-term character in the shareholder’s hands and qualifies for preferential capital gains rates. The REIT must notify shareholders of the designated amount in a written notice mailed within 60 days after the close of the taxable year.11Office of the Law Revision Counsel. 26 USC Subtitle A, Chapter 1, Subchapter M – Regulated Investment Companies and Real Estate Investment Trusts
Unrecaptured Section 1250 Gain
REITs that own depreciable real property often generate unrecaptured Section 1250 gain when they sell, representing the portion of gain attributable to previously claimed depreciation on real property. Passed through to shareholders, this gain is taxed at a maximum 25% rate. It sits between the ordinary rate and the lower long-term capital gains rate, and it appears in its own box on the 1099-DIV. Easy to miss, and meaningfully more expensive than other capital gains.
Return of Capital
Sometimes a REIT distributes more than its current and accumulated earnings and profits. The excess is treated as a return of capital, which is not taxed when received. It reduces the shareholder’s adjusted basis in the shares. When basis reaches zero, further ROC distributions are taxed as capital gains. When the shareholder eventually sells, the lower basis produces a larger taxable gain, so ROC is really a deferral rather than an exemption.
Foreign Shareholders
Non-U.S. shareholders face a default 30% withholding tax on ordinary REIT dividends, subject to reduction under an applicable tax treaty. Capital gain dividends are more complicated. For publicly listed REITs, a foreign shareholder who owns 10% or less of the REIT’s stock is generally subject to the same 30% (or treaty) rate rather than full FIRPTA treatment. Foreign shareholders above that threshold, or holders of shares in a nonlisted REIT, face FIRPTA taxation and higher withholding. The result depends on whether the REIT is listed, whether it is domestically controlled, and the size of the stake, so foreign investors should map their specific situation before assuming a treaty rate applies.
What Happens if a REIT Loses Its Status
A REIT that fails its income tests, asset tests, or the 90% distribution minimum is taxed as an ordinary C corporation for the year. It loses the dividends paid deduction, so all income is taxed at the 21% corporate rate before any distributions reach shareholders. Those distributions are then taxed again at the shareholder level. The double layer wipes out the economic advantage of the REIT structure.
Getting the status back is not quick. A REIT that revokes or loses its election generally cannot re-elect for five years unless the IRS grants a waiver. This is why the spillover, consent, and deficiency dividend procedures matter so much in practice: each is a safety valve for timing problems or later IRS adjustments. A REIT that underdistributes and ignores those tools has no easy path back.