REITs offer motivated investors the benefits of real estate investment without the hassle of owning actual properties. In turn, investors receive dividends consisting of rental income, capital gains, and other earnings such as profits from the sale of a property. Historically, REITs have also provided investors with competitive market performance, transparency, liquidity, inflation protection, and portfolio diversification.
REITs offer comparatively low correlation with other assets, making them an excellent portfolio diversifier with the potential to reduce overall portfolio risk and increase returns. Competitive total returns from REITs are primarily driven by steady dividend income. Often, REIT investments are explicitly made for the potential of REIT dividend earning being paid out over time. Historically, REIT dividend yields produce a steady stream of income through a variety of market conditions. The reliable income returns from dividends over time are a driving force for investors choosing REIT investing for saving or funding toward retirement or another investment.
REIT Dividends
Modeled after mutual funds, REITs function by pooling capital from numerous investors, making it possible for individual investors to earn dividends from real estate investments, all without having to buy, manage, or finance any properties themselves.
By law and IRS regulation, REITs must pay out 90% or more of their taxable profits to shareholders in the form of dividends. REIT investors who receive these dividends are taxed as if they are ordinary income.
Plus, whether REITs are public or private, they must pay out the standard 90% of their income. With a steady income and required dividends, REITs offer a generally profitable return for investors.
How are REIT Dividends Paid?
While a 90% annual dividend payout is required by law and IRS regulation, different REITs pay on different schedules within that requirement.
How often are REIT dividends paid?
- Law requires that REITs pay required dividends at least once annually; however, many REITs pay quarterly or monthly. REIT investors should educate themselves on the payment schedule of a potential REIT investments before investing.
What form of payment do REIT dividends come in?
- REITs can be paid out in cash or a combination of cash and stock but must operate within specific requirements for REIT payouts. This includes the provision that each stockholder elects whether they receive their dividend distribution in all cash or a combination of cash and stock.
- The IRS requires publicly traded REITs to make elective stock dividends, meaning they can be paid in a mixture of stock and cash, but at least 20% of the total distribution must be paid in cash, while 80% can be paid in stocks. This allows a company to save cash while still fulfilling dividend requirements.
What does a typical REIT dividend payout look like?
- While the 90% rule reads as though readers will get very large payouts, understand that the payout ratio is the percentage of net income that a company pays out as dividends. This means that a payout ratio of 20% means that for every dollar of net income, 20% is paid to shareholders in the form of dividends.
- It’s essential to understand that REIT dividend distribution is not based on earnings but a company’s cash flow statement. Dividends from REITs are displayed on the cash flow statement because this statement outlines what a company does with the money it earns (i.e., pays out dividends to shareholders).
How are REIT Dividends Taxed?
REIT dividends are taxed differently depending on the type of dividend payout an investor receives. As with any investment, how dividends are taxed can be complicated and provides disadvantages and advantages to consider.
For dividends consisting of a company’s operating profit, profits are passed through to the shareholder as ordinary income and taxed according to the individual investor’s marginal income tax rate.
Other dividends are paid out as some portion of the operating profit that was previously sheltered from tax due to depreciation of real estate assets. Referred to as the return of capital (ROC), this portion of the payout is considered nontaxable. While this can seem advantageous at the time, reducing the tax liability of the dividend reduces the investor’s per-share cost basis. Essentially, the tax is put off until the dividend is sold at some point in the future.
Lastly, some dividends are paid out as capital gains. It’s important to note how long a REIT company owned that particular asset before it was sold. Assets owned for less than one year are taxed at the investor’s marginal tax rates. However, assets held longer will be taxed at long-term capital gains rates. For investors in the highest tax bracket, this can mean a tax of up to 20%.
Pros
Current federal tax law through 2025 states individuals can take a 20% deduction on pass-through income. Because of this, REIT investors can deduct 20% of their taxable REIT dividend income. This provision does not apply to dividends that qualify for the capital gains rates. Because there is no wage restriction, no cap on the deduction, and itemized deductions are not required to qualify for this benefit, taxpayers in the highest income bracket can experience significantly lowered tax rates.
Cons
While it’s good news in many ways that REITs tend to have above-average dividend yields, it also means they are taxed at higher rates; plus, the type of taxation can be complex based on several factors covered above. Unless you own a REIT in a retirement account, you will likely be taxed at the corporate level and on an individual basis. Dividends on public REITs are taxed as ordinary income, so there is no significant tax break for investors.
Conclusion on REIT Dividends
With a reputation of high dividend payouts and portfolio diversification, many investors turn to REIT investing as an alternative way to invest. REITs allow investors to invest in an entire portfolio of income-producing real estate without the burden of owning and managing individual properties. However, it’s essential that interested investors fully understand the intricacies of REIT dividend distributions, as it determines the income potential of the investment. Understanding the laws surrounding REIT dividend distributions will help investors realize the actual potential value of their investment over time.
