Real estate investment trusts (REITs) often offer high dividend yields and provide diversification from common stocks.
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In fact, one study by the American Teachers Insurance and Retirement Association of investment portfolios from 2000 to 2020 found that REITs helped improve risk-adjusted returns.
But do REITs also offer tax benefits? Keep the following in mind before investing:
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No corporate tax
As a general rule, REITs do not pay separate corporate taxes. This prevents profits from being diluted by taxes.
To qualify for this exemption, a company must return at least 90% of its profits to investors in the form of dividends.
Dividends are taxable
Like all stocks and funds, REIT dividends are taxed as regular income.
In a sense.
Of course, you can avoid taxation by holding REITs in a Roth IRA or Roth 401(k). But REITs have some less common tricks up their sleeve.
return of capital
Real estate investment trusts can classify a portion of their dividends as a return of capital rather than a taxable distribution.
In this case, there is no tax on that portion of the dividend income. However, once the capital is returned, the cost goes down and you get a higher capital gain when you sell.
But Uncle Sam has a lower long-term capital gains tax rate, which puts you at an advantage. You can also perform other trick plays such as recovering losses to offset capital gains taxes.
TCJA 20% pass-through deduction
The Tax Cuts and Jobs Act of 2017 (TCJA) created a 20% deduction on qualified business income. This deduction reduces your taxable dividend income by 20% without any payroll restrictions. There is also no need to itemize your deductions.
That being said, the repeal of the TCJA at the end of 2025 will result in tax changes. Congress may or may not vote to extend it, but for now he shouldn't count on it beyond 2025.
final thoughts
Real estate investment trusts have certain advantages. They remain one of the only liquid ways to invest in real estate, which is a notoriously illiquid asset.
However, you should only invest in REITs if it makes sense for your investment goals and risk tolerance. Don't invest solely for the tax benefits.
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When exploring passive ways to invest in real estate, you may also want to consider real estate crowdfunding platforms and private equity real estate investments (such as syndications). They don't have the liquidity of REITs, but they have lower volatility and often have tax benefits.
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This article originally appeared on GOBankingRates.com: Do REITs offer tax benefits? Here's what investors need to know
