Real Estate Investment Trusts (REITs)

A real estate investment trust is a corporation that owns, operates, or finances income-producing real estate and elects to be taxed as a pass-through entity instead of a regular C-corp. Two Code sections do the work, and they are routinely merged into one. IRC §856, “Definition of real estate investment trust” sets the qualification tests: at least 75% of assets in real estate, cash, or government securities ( IRC §856(c)(4)); at least 75% of gross income from rents, mortgage interest, or property sales, and at least 95% from those plus other passive sources ( IRC §856(c)(2)–(3)). IRC §857, “Taxation of real estate investment trusts and their beneficiaries” then sets the price: IRC §857(a)(1) conditions REIT status on distributing at least 90% of REIT taxable income each year, which the entity achieves through the deduction for dividends paid under IRC §857(b)(2)(B).

Meet all of it and the REIT pays essentially no corporate-level tax on distributed income — it still pays tax on anything it retains, which is why almost none of them retain anything. The investor receives the dividends and pays at ordinary rates, with a partial offset from the IRC §199A, “Qualified business income” qualified business income deduction (made permanent by OBBBA).

REITs come in two structural flavors — equity REITs that own physical properties, and mortgage REITs that hold real-estate debt — and trade either publicly on exchanges or privately. The 90% distribution requirement makes them high-yield, low-capital-growth instruments: most of the total return flows out as ordinary income dividends instead of capital appreciation. That dictates asset location: REITs go into tax-deferred wrappers first, and into taxable accounts only once those are full and the REIT’s distributions are mostly return of capital (section “REITs”).