INSIGHT

Tax benefits and considerations of REITs 

Tina Trimble, Tara Wilson • July 22, 2025

Industries: Real Estate Investment Trusts (REITs)

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Real estate investment trusts (REITs) offer investors a practical way to gain exposure to real estate without directly owning or managing properties.  Along with potential income and diversification benefits, REITs also come with specific tax advantages and structural requirements that are important to understand.     

The unique REIT tax benefits and considerations make these vehicles a powerful tool for optimizing after-tax returns and managing tax liability.  

Navigating REIT Taxation and Compliance 

Understanding the nuances of REIT dividends, capital gains, and the broader tax treatment of REIT shares is essential for maximizing value and maintaining compliance in the real estate market.  

Avoidance of double taxation 

Unlike traditional C corporations, which pay corporate income taxes on their profits, and then distribute after-tax profits as dividends (which are taxed again at the shareholder level); REITs are generally considered pass-through entities and do not pay federal corporate income taxes on the portion of income distributed to shareholders.  

REITs avoid corporate-level taxation by distributing most of their income to shareholders as dividends.  REITs are required to distribute at least 90% of their taxable income to shareholders.  By distributing these dividends, REITs can deduct the amount from their taxable income, effectively eliminating or significantly reducing their tax burden at the entity level.   

Consequently, more of the REIT’s earnings flow directly to shareholders, enhancing cash flow and overall yield. 

To maintain their tax-advantaged status, U.S. REITs must meet several IRS requirements.  In general terms, these requirements include: 

Distribution Requirement  

• A REIT must distribute at least 90% of their taxable income to shareholders. 

Asset Requirement 

• On a quarterly basis, at least 75% of a REIT’s assets are required to be real estate assets, cash, or U.S. government securities. 
• A REIT cannot own, directly or indirectly, more than 10% of the voting securities of a corporation, with the exception of another REIT, a taxable REIT subsidiary (TRS) or a qualified REIT subsidiary (QRS).   
• A REIT cannot own stock in a corporation, with the exception of another REIT, TRS or QRS, in which the value of the stock consists of more than 5% of a REITs assets. 
• The value of the stock of a REIT’s TRSs cannot exceed 20% of the value of the REIT’s assets.  Effective for taxable years beginning after December 31, 2025, the permissible value of TRS securities that a REIT may hold will increase from 20% to 25% of the value of the REIT’s total assets. 

Income Requirement 

• At least 75% of the REIT’s annual gross income must be derived from real estate-related sources, such as rents from real property and/or interest on debt obligations secured by real property. 
• In addition to the 75% real estate-related income, 95% of a REIT’s gross income must be derived from passive sources such as rents from real property, interest, dividends, and gains from real estate or security sales.   
• REIT’s income from non-qualifying sources, such as service fees or a non-real estate business must be less than 5% of the REIT’s total gross income. 

Organizational Requirement 

• A REIT must be structured as a corporation, trust, or association and managed by a board of directors or trustees, and its shares must be transferable. 
• Beginning with its second taxable year, a REIT must have at least 100 shareholders and no more than 50% of the value of the REIT’s shares may be held by five or fewer individuals during the last half of each taxable year. 

By meeting these requirements, and because REITs are allowed a deduction for dividends paid, REITs can generally avoid paying corporate income taxes on distributed earnings; thus passing the tax obligation directly to shareholders and maximizing after-tax returns. 

Favorable dividend treatment 

Ordinary REIT dividends are typically taxed as ordinary income at the investor’s regular income tax rate, rather than the lower qualified dividend rate.  However, investors may deduct up to 20% of qualified REIT dividends as a qualified business income deduction (Section 199A qualified business income deduction), a benefit which was made permanent by the One Big Beautiful Bill Act passed in 2025.   

The deduction effectively reduces the top federal tax rate on REIT ordinary dividends from 37% to 29.6% for high-income investors.  With respect to the 20% Section 199A deduction from REIT dividends, there is no cap, no wage restriction, and no requirement to itemize deductions in order to receive the benefit.  

• It is important to note that higher-income investors face amplified tax liability due to the 3.8% Net Investment Income Tax (NIIT) on REIT distributions.  
• Secondly, when a REIT sells property held for more than a year for a profit, the investor is taxed on the distributed capital gains at long-term capital gains rates. 
• A third tax benefit to investors with respect to a REIT income stream is that return of capital (ROC) distributions (distributions in excess of the REIT’s taxable income) are not taxed immediately but reduce the investor’s cost basis, deferring taxation until the REIT shares are sold.  Upon sale of the REIT shares, the accumulated ROC is taxed as a capital gain. 

Reliable income stream for investors 

As mentioned above, REITs are required to distribute at least 90% of their taxable income to shareholders annually.  This distribution requirement offers benefits to both the REIT and its investors.  The deduction from taxable income for dividends paid allows the REIT to avoid paying corporate income tax, and it provides investors with a steady income stream and potential tax advantages. 

Simplified state tax reporting 

Although a REIT may own properties in multiple states, shareholders generally only recognize dividends in their state of residence, eliminating the need for filing taxes in multiple states. 

No UBTI for tax-exempt investors 

Generally, dividends from REITs are not considered Unrelated Business Taxable Income (UBTI) for tax-exempt investors.  REITs are structured to convert income from real estate, which could be subject to UBTI if earned directly, into dividends that are typically excluded from UBTI for tax-exempt entities.  There are a few exceptions including: 

• REITs as taxable mortgage pools 
• Income from non-customary services performed by a REIT could be considered non-qualified and potentially trigger UBTI if it exceeds certain thresholds. 
• REITs heavily owned by pension plans may be subject to special rules that could cause those investors to recognize UBTI. 

Advantages for foreign investors 

Foreign investors can access U.S. real estate through REITs with fewer tax complications than direct ownership.  

If the REIT is “domestically controlled” (D-REIT) (less than 50% foreign ownership), sale of REIT stock by foreign investors is excluded from the Foreign Investment in Real Property Tax Act (FIRPTA), consequently foreign investors can avoid filing a U.S. tax return or paying U.S. capital gains tax on the sale of D-REIT shares. However, dividends and capital gains distributions to foreign investors are generally subject to U.S. withholding taxes, with rates that vary by country and treaty.    

Build a custom REIT strategy with BPM 

REITs offer a compelling combination of steady income, portfolio diversification, and distinctive tax advantages. By understanding how REIT distributions are taxed, leveraging the qualified business income deduction, and strategically managing account types and withdrawals, investors can maximize after-tax returns and minimize tax burden.  

However, REITs also present unique considerations—including UBTI risks, state tax complexities, and special rules for foreign and tax-exempt investors—that require careful planning. 

Navigating these complexities is essential to fully realize the benefits of real estate investment trusts. For tailored strategies that align with your goals and the latest tax laws, connect with BPM’s REIT team.