Real estate investment trust (REIT) stocks are shares of companies that must own or finance real estate to qualify for special REIT tax rules. One benefit of the REIT tax rules is that these companies often must pay very attractive dividends to maintain their REIT status. On the flip side, though, investors get no special tax benefits from REIT dividends.
A company that qualifies to be a REIT under the tax rules does not pay federal corporate income tax. To maintain its tax-exempt status, a REIT must pay out at least 90 percent of its annual net income as dividends to shareholders. As a result, the dividends paid on a REIT stock represent profits that have not been taxed. Because of the tax benefits of owning real estate, such as depreciation write-offs, it is not uncommon for a REIT to pay dividends greater than the reported net income.
Qualified vs. Non-Qualified Dividends
Dividends earned from stock shares have either qualified or non-qualified tax status. The dividends paid by a corporation that pays corporate income tax on the profits before dividends are paid, fall into the "qualified" category. The tax rate on qualified dividends is much less -- 0 or 15 percent for most taxpayers -- than the investor's regular income tax bracket. However, since a REIT pays no corporate income tax, the dividends from REIT stocks are not qualified.
Dividends Taxed at Your Regular Rate
If you own REIT shares in a regular brokerage account, the tax rate you pay on the REIT dividends will be your regular, marginal income tax rate. The Form 1099-DIV you receive from your broker includes the REIT dividends in the total ordinary dividends box, but those distributions will not be included in the qualified dividends box. With qualified dividends -- not REIT dividends -- the money has been taxed at the corporate level and on your tax return. As non-qualified dividends, the REIT distributions are only taxed once, but at a higher rate.
Own REITs in a Tax-Advantaged Account
If your portfolio -- or plans for one -- includes owning stocks that pay both qualified and REIT dividends, you may want to include some tax planning in your stock investment strategy. If you own REIT shares in a tax-advantaged account -- such as a traditional or Roth IRA -- you get around paying the higher tax rate on the REIT dividends. Own the stocks that pay qualified dividends in a regular brokerage account to take advantage of the lower tax rate on those earnings.
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