Very few private citizens have the funds to invest in commercial properties on their own. If you are interested in owning a piece of this type of the real estate pie, investing in an REIT can be the right choice for you. These investments, which share characteristics of mutual funds and stocks, allow people to own part of commercial properties. The dividends that a REIT pays out can be considered a qualified dividend if it meets the requirements set by the IRS (Internal Revenue Service).
What is a REIT?
A REIT, which stands for real estate investment trust, is a company that either owns commercial properties directly or provides financing for them. A number of REITs are registered with the Securities and Exchange Commission.
If you are interested in buying into REITs, you can buy into the company individually, just like you would buy stock. You can also buy a mutual fund that invests in REITs. When you invest in an REIT, you can own a portion of various varieties of commercial properties. Examples include the following:
- Self-storage units
- Shopping centers
- Strip malls
- Office buildings
- Parking garages and parking lots
- Clinics and hospitals
REITs make money by leasing space to commercial tenants and collecting rent from them. The income is paid out as dividends to shareholders. REITs are required to pay out a minimum of 90 percent of their taxable income to their shareholders.
Ordinary Dividends and Income Taxes
According to the IRS, ordinary dividends are a common distribution method used by corporations or mutual funds. These amounts are paid out of the corporation or mutual fund’s profits and earnings and are considered income. Dividends are not taxed as capital gains.
Are REIT Dividends Qualified Dividends?
Dividend taxation recognizes two types of dividends: qualified dividends and ordinary dividends. Qualified dividends are taxed at the same maximum tax rate (zero percent, 15 percent and 20 percent) as net capital gains. If a dividend is being treated as a qualified dividend, it will appear in Box 1b of Form 1099-DIV that you will receive from the issuing company or mutual fund.
The maximum tax rates for qualified dividends is calculated as follows:
- No tax payable on amounts that would otherwise be taxed at 10-15 percent.
- Fifteen percent tax charged on an amount that would normally have been taxed at 15-39.6 percent.
- Twenty percent tax charged on an amount that would normally have been taxed at a rate of 39.6 percent.
In order to qualify for the maximum discounted tax rate, the dividends must either have been paid by a United States corporation or a qualified foreign one. A foreign corporation is considered qualified if:
- it was incorporated in a United States possession;
- it was incorporated in a country the United States currently has an income tax treaty with; or
- its stock is trading on “an established securities market in the United States.”
Before you decide whether investing in REITs is the right choice for you, do review the idea with an experienced financial professional who can explain this option to you in detail and advise you about how it can fit into your overall financial plan.