Real estate investment trusts (REITs) often pay high dividend yields and offer diversification from typical stocks.
Check Out: 7 Best Stocks To Buy Under $1
Read Next: 6 Unusual Ways To Make Extra Money (That Actually Work)
In fact, one study of investment portfolios from 2000-2020 by the Teachers Insurance and Annuity Association of America found that REITs helped improve risk-adjusted returns.
But do REITs also come with tax benefits? Keep the following in mind before investing.
No Corporate Taxes
As a general rule, REITs don’t pay separate corporate income taxes. That helps prevent returns from being diluted by taxes.
To qualify for this exemption, they must pass along at least 90% of their profits to investors in the form of dividends.
Dividends Are Taxable
Like all stocks and funds, dividends on REITs are taxable as regular income.
Sort of.
You can of course avoid taxation on them by holding your REITs in a Roth IRA or Roth 401(k). But REITs come with a few less common tricks up their sleeves.
Return of Capital
Real estate investment trusts can categorize some of their dividend payments as return of capital, rather than taxable distributions.
In this case, you pay no taxes on that portion of the dividend income. However the return of capital reduces your cost basis, setting you up for higher capital gains upon sale.
But Uncle Sam charges lower rates for long-term capital gains taxes, which sets you up for a win. And you can pull other trick plays like tax loss harvesting to offset capital gains taxes.
TCJA 20% Pass-Through Deduction
The Tax Cuts and Jobs Act of 2017 (TCJA) created a 20% deduction for qualified business income. That deduction reduces your taxable dividend income by 20%, with no wage restrictions. It also doesn’t require you to itemize deductions.
That said, the tax changes created by the TCJA sunset at the end of 2025. Congress may or may not vote to extend them, but for now don’t count on them past 2025.
Final Thoughts
Real estate investment trusts come with their share of advantages. They remain one of the only liquid ways to invest in real estate — a notoriously illiquid asset.
But you should only invest in REITs if they make sense for your investing goals and risk tolerance. Don’t invest for the tax benefits alone.
Learn More: Retirement Savings: I Lost $400K in a Roth IRA
As you explore passive ways to invest in real estate, consider real estate crowdfunding platforms and private equity real estate investments (such as syndications) as well. While they don’t offer the liquidity of REITs, they come with less volatility and often better tax benefits.
More From GOBankingRates
- 7 Bills You Never Have To Pay When You Retire
- 6 Hybrid Vehicles To Stay Away From Buying
- Here's How to Add $200 to Your Wallet -- Just For Banking Like You Normally Would
- I Retired in My 70s: Here's My Monthly Budget
This article originally appeared on GOBankingRates.com: Do REITs Offer Tax Benefits? Here’s What Investors Should Know
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
