Ask the Experts: How will my REIT dividends be taxed for federal tax purposes?
In order to qualify as a REIT, a company must comply with several strict tax rules. One of these rules requires a REIT to distribute at least 90% of its taxable income to shareholders each year (if it does, it pays no corporate income tax). As a shareholder, this income is paid to you in the form of dividends, which come from the REIT’s rental income, profits from the sale of property, and other services provided to tenants.
Generally, you must pay income tax on the dividends you receive from your REIT investment. But REIT dividends are taxed at different rates depending on whether they are classified as ordinary income or capital gains. Thankfully, you won’t have to figure this out yourself. All REITs are required to provide their shareholders each year with IRS Form 1099-DIV, which clarifies how the prior year’s dividends are to be allocated for tax purposes.
Most REIT dividends are classified as ordinary income because they consist of rents or other earnings that are being passed through to you, the shareholder. Unfortunately, this type of REIT dividend is not entitled to the lower dividend tax rates (maximum 15%) established by Congress in 2003 in the Jobs and Growth Tax Relief Reconciliation Act that apply to most dividends. (The act also lowered the tax rate on most capital gains to a maximum 15%.) Instead, these dividends will continue to be taxed at ordinary income tax rates, at a maximum rate of 35%.
But REIT dividends that are classified as capital gains will qualify for the lower capital gains tax rate. To the extent that a REIT realizes long-term capital gain from the sale of some of its property or generates qualified corporate dividends, either of which it passes along to you, these proceeds should qualify for the lower capital gains tax rate (maximum 15%). And the lower rate will apply when you sell your REIT shares for a profit, as long as you’ve held the shares for at least a year.