Real estate investment trusts let you own pieces of apartment buildings, factories and skyscrapers through your individual retirement account. Much like a mutual fund, a REIT pools money from many investors and uses the cash to buy a portfolio of investments. Instead of stocks, REITs own buildings and spin off the cash flow from operating them to you, along with any profits or losses from periodically buying and selling them.
REITs often own portfolios of large properties like office buildings that collect rent every month. REITs are set up to maximize their dividend payments to you, instead of holding on to earnings to make their share prices go up, so you get your growth in cash. You can reinvest the money or tap the cash to meet your yearly minimum distribution requirement, when you're old enough you need to pull it out.
Potential Tax Savings
Because REITs usually don't pay corporate income taxes, their dividends are typically taxed as regular income if you own them outside your IRA. Depending on your tax situation, this means you might pay the same rate on dividends coming out of an IRA as you would if you held a REIT in a taxable account. The money that comes from your IRA is always regular earned income, even it's a capital gain or qualified dividend.
While REITs are often traded on the stock market, they don't reflect ownership of a company like a mutual fund does. Ultimately, when you buy REITs, you're buying pieces of buildings. This means they have similar performance characteristics to real estate, including the ability to hedge against inflation. In times of high inflation, rent goes up, the value of real estate grows and the value of REIT shares also typically rises. When everyone else is losing, you're winning.
REITs can get caught up in major market shifts. When the businesses renting space in a REIT's office buildings fall on hard times, they may move out and not be replaced by other tenants, hurting your investment. With this in mind, REITs aren't a substitute for fixed-income investments in a conservative portfolio.
Sometimes the income you earn in your IRA can be taxable even if the account is tax-free Roth. This is because of the "unrelated business taxable income" rules from the Internal Revenue Service. REITs can be prone to this nasty tax. Generally, you would only be on the hook if more than 25 percent of a REIT's shares were owned by a pension plan or the REIT owned certain types of mortgages. One way to avoid the UBTI tax is to stay away from mortgage REITs.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.