Real estate investment trusts (REITs) have many potential benefits for investors. They can produce significant dividend income, diversify portfolios, and provide the opportunity for long-term capital gains.
Investors receive funds from REITs in the form of dividends. Dividends have specific IRS tax guidelines depending on their type. Learning more about REIT dividends helps you prepare your tax return correctly. You can make more informed decisions about your investment type and long-term financial goals.
Qualified REIT Dividends Defined
Dividends are a distribution of corporate earnings given to a company’s shareholders. You might receive dividends if you own stocks in a company or a mutual fund that includes stock that pays dividends. Qualified dividends are a particular type of dividend you can report on taxes as a capital gain instead of income. Capital gains typically have lower tax rates than income taxes, allowing for increased savings when you file taxes.
The United States Internal Revenue Service (IRS) states that qualified dividends must:
- Meet the required holding period: You must hold the dividend for a certain period before the IRS considers it qualified. This requirement prevents people from purchasing stock at the last moment to benefit from the tax advantage. You must hold the dividend for over 60 days in a 121-day time frame. This time frame should also occur at least 60 days before the ex-dividend date, set one day before the record date.
- Be unhedged: Qualified dividends must also be unhedged — you cannot protect them against loss with balancing contracts during the holding period.
- Be paid for by a qualified company: A qualified United States or foreign corporation must pay for the dividend.
The major benefit of qualified dividends is the lower tax rate. Exact tax rates vary by income bracket, but they are lower than typical income tax rates. Certain income thresholds might be taxed at 0%.
What Are REITs Dividends?
Real estate investment trusts are entities that operate or finance income-producing real estate properties. They combine funds from investors to purchase properties. In return, investors and shareholders receive dividends from rental income without buying or running the property themselves. How liquid REITs are depends on whether they are traded or non-traded.
Due to its REIT status, the entity avoids being considered a regular corporation. The IRS has several requirements for REIT qualifications. For instance, except for capital gain dividends, all distributed dividends must be at least 90% or more of the REIT’s taxable income. The majority of its assets should also be from real estate.
Why Are REIT Dividends Not Qualified?
REIT investors receive dividends once or multiple times each year. However, the dividends are usually not considered qualified. They are taxed like normal income, preventing REIT shareholders from benefiting from the lower tax rate.
REIT dividends are not qualified because the IRS considers them as pass-through income. These are profits that get distributed to investors without the entity paying taxes first. REIT dividends pass to investors as ordinary income. The IRS taxes the dividends according to the individual investor’s income tax rate.
However, REITs might generate other income types that determine different tax treatments. For instance, REIT dividends might be distributed as:
- Capital gains: If the REIT sells a property for more than the amount it paid, it might receive capital gains during the process. The IRS does not consider these funds regular income, so the tax requirements are different. Your capital gains tax depends on your annual income and filing status.
- Return of capital: These payments occur when investors receive part of their investment back from the REIT. The IRS does not consider a return of capital under the same tax requirements as ordinary income.
Investors can learn more about their tax dividend breakdown on a 1099-DIV form. Investors receive a form from their brokers at the end of the tax year that summarizes investor activity. Dividend tax requirements can vary depending on payout type, so working with a tax professional is recommended when determining tax rates and other essential data.
How Do You File Taxes for REITs?
Investors need to follow proper tax reporting and filing rules for REIT dividends. You should receive a 1099-DIV form each year if you own shares in a REIT. This document lists your total received amount from dividends and their type. You can use this information and the provided instructions to report the dividends to the IRS.
Your 1099-DIV contains crucial data, located in the following boxes:
- Box 1: This box lists the dividends that are considered ordinary income.
- Box 1b: This box lists any qualified dividends.
- Box 2a: This box lists capital gains dividends.
- Box 3: This box lists any return of capital investments.
These crucial details provide the information you need to file taxes correctly. You must pay regular income tax on dividends considered as ordinary income. However, capital gains and return of capital dividends have different requirements. Capital gain tax rates can be either short- or long-term, depending on how long you owned the investment. Return of capital investments are usually not taxed because they qualify as your own money.
Investors use the IRS form 1040 to report received dividends. This form helps you calculate any owed taxes, which you send to the IRS as part of your annual tax return.
The 1099-DIV also provides detailed instructions for proper filing techniques. It helps to work with a financial advisor or tax professional when determining how to file taxes for your REIT dividends.
As with any discussions of tax matters, you should always consult with your tax professionals since your specific situation will differ and could affect the applicability of this information.
Learn More About REIT Investments With 1031 Crowdfunding
Most REIT dividends are not qualified, so investors follow typical income tax requirements. Understanding the dividend type you receive and how it affects your tax returns is important. While the IRS form 1099-DIV is useful for the filing process, professional financial advisors can also help.
1031 Crowdfunding is a leading real estate investing platform. Our top-quality platform and resources can assist with investment decisions. We personalize our services to align with your unique investment goals and provide ongoing support. Learn more about REITs and their impact on taxes with our guidance.
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