Investors in Real Estate Investment Trusts (REITs)
Enjoy Enhanced Opportunities Under The Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (TCJA) has created increased opportunities tax wise for investors in real estate investment trusts (REITs).
REITs are collective funds that allow investors to pool their capital and make diversified investments in real estate by purchasing shares of a real estate trust. REITS offer a lower-risk alternative for investors to get exposure to the real estate market without actually buying physical property, in a platform that is liquid. Investors in REITs have the opportunity to invest in large-scale, diversified portfolios of income-producing real estate.
An IRS provision requires a REIT to return a minimum of 90 percent of its taxable income back to shareholders each year thereby creating a low-cost investment that is virtually guaranteed to give something tangible back to investors at the end of the year.
Section 199A of the TCJA, also known as the qualified business income deduction (QBI deduction) has greatly enhanced the benefits of a REIT investment.. When applied to REIT investors, the QBI deduction consists of two components: the QBI component and the REIT/publicly traded partnership (REIT/PTP) component. Investors can deduct the lesser of the QBI component plus the REIT/PTP component, or 20 percent of the taxpayer’s taxable income minus net capital gain. Because the majority of REIT distributions will be classified as qualified REIT dividends, REITs might provide a higher deduction than could be obtained through direct ownership of real estate, particularly for high income payers.
In addition, the burden of proof for meeting these tax deduction requirements with a REIT investment is fairly straightforward. Simply by owning a REIT, the investor qualifies. In contrast, if traditional real estate investors want to qualify for the QBI deduction, they must prove the income they plan to deduct is from a qualified trade or business. To take advantage of a beneficial safe harbor, the property’s owner must meet rigorous requirements, including a mandate that at least 250 hours be spent in the calendar year managing the property.
The tax advantages of REITs, coupled with the opportunity to diversify a portfolio, certainly create an attractive combination. However, before investors buy in, it’s important that tax professionals understand both the intricacies of the QBI deduction and ensure a REIT is aligned with the client’s investment goals.
In addition to the usual investment questions — how diversified are the properties, is management experienced, what’s the dividend history, is the REIT highly leveraged — they’ll have to understand the tax nuances to make sure it’s the right addition to their portfolio.