It’s my annual Taxes from A to Z series! This time, it’s Tax Cuts and Jobs Act (TCJA) style. If you’re wondering whether you can claim home office expenses or whether to deduct a capital loss under the new law, you won’t want to miss a single letter.
R is for Real Estate Investment Trust.
Want to buy a hotel? Or perhaps a shopping mall? Most taxpayers don’t have the resources to build a commercial real estate portfolio on their own. But in 1960, Congress created Real Estate Investment Trusts (REITs): with a REIT, an individual investor can buy a share in a commercial real estate portfolio. The individual investors turned shareholders make money the same way that the bigger real estate investing fish do: by taking a percent or income generated by renting, leasing or selling the real estate. It’s just at a smaller clip.
The tax rules that apply to REITs can be complex. Generally, to qualify as a REIT, an organization must be a corporation, trust, or association and must be managed by one or more trustees or directors (typically appointed by the shareholders). REITs may not be closely held. There must be at least 100 shareholders in a REIT and the ownership must be evidenced by transferable shares or certificates of beneficial interest.
REITs receive special tax treatment so long as they pay out at least 90% of their income as dividends (REITs often pay out close to 100%). For federal income tax purposes, REITs file a form 1120-REIT, U.S. Income Tax Return for Real Estate Investment Trusts (downloads as a PDF). The return is much like a form 1120-S for an S corporation because REITs are also pass-through entities: that means that REITs don’t pay federal income tax at the corporate level but instead passes the income (but not the losses) to the shareholders to report on their individual returns.
REITs were already considered pretty tax-favored, but under the TCJA, things got better: Qualified REIT dividends may be eligible for the pass-through deduction under section 199A. Qualified REIT dividends are those REIT dividends that are neither qualified dividend nor capital gain dividends (remember, income generally needs to be active income to qualify for the pass-through deduction). Special rules, including holding periods, apply. You can check out the proposed Regs for more information (downloads as a PDF).
(For more on the pass-through deduction, click here.)
And that’s not all: REITs may also form opportunity zone funds to acquire and develop properties – and take advantage of favorable tax treatment. Specifically, if the investments qualify, capital gain on the sale of assets can be deferred and reduced – potentially to zero.
(For more on opportunity zones, click here.)
Some REITs carry a higher risk than others, so be sure to do your homework before investing. And, of course, check with your tax professional if you have questions about how investing in a REIT might impact your tax bill.
For more Taxes From A To ZTM 2019, check out the rest of the series: