REIT Investing: Pros, Cons and Tax Considerations

Investing directly in real estate can offer tax and investment benefits, but not every investor wants to be a hands-on landlord. For those investors, a real estate investment trust may offer another way to invest in real estate.

One alter­native is a real estate investment trust (REIT), a company that owns, operates, or finances income-producing real estate. REITs allow investors to gain real estate exposure without directly buying or managing property.

REITs may own apartment buildings, student housing, warehouses, data centers, medical buildings, office buildings, and other properties. They can add diver­si­fi­cation to a portfolio, although diver­si­fi­cation does not guarantee a profit or protect against loss. Some REITs may also provide a partial hedge against inflation if property owners can raise rents as costs rise.

REITs also carry risks. Publicly traded REITs can decline in value, and their income and market prices may be affected by interest rates, property values, tenant demand, economic condi­tions, and the type of real estate they own. During the calendar year 2022, for example, the real estate category average lost 25.5% compared to the S&P 500 index, which was down 18.1%.¹

There’s no doubt that the tax consid­er­a­tions of any investment are important. Yet we don’t make investment recom­men­da­tions based on tax benefits alone. An investment must first make sense as part of the overall portfolio strategy.

How REIT Distributions Are Taxed

Most REIT dividends held in a taxable account are taxed as ordinary income rather than at the lower qualified-dividend rates. Unlike regular corporate stock, REIT dividends do not qualify for prefer­ential tax treatment (which means in the top tax bracket, they’re taxed at 37%).

2026 Qualified Dividend Tax Rates

At the trust or company level, REITs do not receive qualified tax treatment because they typically don’t pay corporate taxes. The IRS requires that at least 90% of a REIT’s taxable earnings be distributed to share­holders as dividends. This is one reason REITs are viewed as a good source of passive income.

REIT dividends, on the other hand, receive a tax preference: IRC Section 199A, which provides a 20% deduction of any qualified REIT dividends for taxpayers. This effec­tively results in a 20% reduction in the REIT tax rate, reducing the top rate to 29.6%.

REIT Dividends vs. Qualified Dividends

The One Big Beautiful Bill Act, enacted in 2025, made the Section 199A deduction permanent under current law.

Return of Capital

A portion of the REIT distri­b­ution could be classified as a return of capital (ROC) often because depre­ci­ation and other deduc­tions reduce the REIT’s taxable income. ROC generally is not taxable when received. Instead, it reduces the investor’s cost basis in the shares, which can increase the taxable gain, or reduce the loss, when the shares are later sold. If basis is reduced to zero, additional ROC generally is treated as a capital gain.

The downside, however, is that reducing the cost basis can trigger a larger capital gain if you sell the REIT later. One solution is to employ an aggressive tax-loss harvesting strategy with other money in your portfolio, booking the losses and using them to offset the capital gain from selling the REIT. The IRS allows you to offset long-term capital gains with long-term capital losses. Unused losses in the current year can be carried forward indef­i­nitely on your federal tax return (state rules vary). Return of capital can be a signif­icant tax advantage for REIT investors.

How REIT Distributions Are Reported

REIT owners receive Form 1099-DIV, Dividends and Distri­b­u­tions from their account custodian to report their qualified REIT income. (The infor­mation appears on Schedule B and carries directly onto Form 1040 of your tax return.)

REIT distri­b­u­tions fall into three separate categories:

• Ordinary income: Your REIT dividends are taxed as ordinary income according to your marginal tax rate. (There are two parts to “Box 1” of the 1099-DIV, one for ordinary dividends and another for qualified dividends, which are taxed at a lower rate.)
• Capital gains: When a REIT sells a property held for at least one year, the gains are taxed at 0, 15, or 20 percent, depending on your tax bracket. Capital gains received from a REIT are always taxed as long-term gains regardless of whether you’ve held the position for 12 months. This is shown in Box 2a of the 1099-DIV.
• Return of capital: These distri­b­u­tions are not taxed and can be used to reduce the invest​ment’s cost basis. They are reported on Box 3 of your 1099-DIV.

Should You Hold REITs in a Taxable Account or IRA?

Because many REIT distri­b­u­tions are taxed as ordinary income and can require basis tracking, a tax-advantaged account may be appro­priate in some situa­tions. Holding a REIT in an IRA or qualified retirement plan generally defers current taxation and elimi­nates annual basis tracking for ROC distri­b­u­tions within the account.

A taxable account may also be appro­priate. However, it certainly makes more sense to hold them in a tax-deferred IRA due to the complex REIT taxation rules. While distri­b­u­tions from IRAs and 401(k)s are both 100% taxable as ordinary income, owning REITs in taxable accounts may allow you to take advantage of the return of capital and 199A rate reduc­tions, which could reduce the taxes on distributions.

Taxes aren’t the only investment consid­er­ation with REITs, but they’re something to pay attention to. There are many types of REITs and different kinds of ownership, such as publicly traded REITs vs. non-traded REITs. Working with a financial adviser who can help you navigate the choices is essential.

Insights:

• REITs can provide real estate exposure and portfolio diver­si­fi­cation without requiring investors to manage property directly.
• The IRS requires at least 90% of a REIT’s taxable earnings to be distributed to share­holders to avoid corporate taxation.
• Since 2018, REITs have been given a new tax preference: the IRC Section 199A deduction that provides a 20% deduction of any qualified REIT dividends.
• REITs may also distribute return of capital which is not taxable but does reduce the owner’s cost basis in the security.

This article was origi­nally published on August 15, 2023, and was updated for accuracy and relevance on the date above.