7977 / How is a shareholder (or beneficiary) in a real estate investment trust taxed?

Ordinary income dividends. Under JGTRRA 2003, qualified dividend income is treated like net capital gain for most purposes (see Q 702) and is, therefore, eligible for the 20 percent/15 percent/0 percent tax rates instead of the higher ordinary income tax rates. ATRA made these tax rates permanent for tax years beginning after 2012. Because REITs generally do not pay corporate income taxes, most ordinary income dividends paid by REITs do not constitute qualified dividend income, and, consequently, are not eligible for the 20 percent/15 percent/0 percent rates.² However, a small portion of dividends paid by REITs may constitute qualified dividend income—for example, if the: (1) dividend is attributable to dividends received by the REIT from non-REIT corporations, such as taxable REIT subsidiaries; or (2) income was subject to tax by the REIT at the corporate level, such as built-in gains, or when a REIT distributes less than 100 percent of its taxable income.

REITs that pass through dividend income to their shareholders must meet the holding period test (see Q 702) in order for the dividend-paying stocks that they pay out to be reported as qualified dividends on Form 1099-DIV. Investors must also meet the holding period test relative to the shares they hold directly, from which they received the qualified dividends that were reported to them.³

Unless designated by the REIT as qualified dividend income, all distributions are ordinary income dividends.⁴ Ordinary income dividends are included in the shareholder’s (or beneficiary’s) income for the taxable year in which they are received. Shareholders do not include a share of a REIT’s investment expenses in income, nor with the shareholder’s miscellaneous itemized deductions, as is the case with certain other pass-through entities. See Q 733.

Capital gain dividends. Capital gain dividends are designated as such by the REIT in a written notice to the shareholder (beneficiary).⁵ The shareholder (beneficiary) reports capital gain dividends as long-term capital gain in the year received, regardless of how long the shareholder has owned an interest in the REIT.⁶ See Q 702 for the treatment of capital gains and losses, including the lower rates under JGTRRA 2003 (20 percent/15 percent/0 percent) for long-term capital gains incurred on or after May 6, 2003—now made permanent by ATRA—and the availability of the election to include net capital gain in investment income.

If the total amount designated as a capital gain dividend for the taxable year exceeds the net capital gain for the year, the portion of each distribution that will be a capital gain dividend will be only that proportion of the amount so designated that such excess of the net long-term capital gain over the net short-term capital loss bears to the total amount designated as a capital gain dividend. For example, a REIT making its return on the calendar year basis advised its shareholders by written notice mailed December 30 that $200,000 of a distribution of $500,000 made December 15 constituted a capital gain dividend, amounting to $2 per share. It was later discovered that an error had been made in determining the net capital gain of the taxable year, which turned out to be $100,000 instead of $200,000. In such case, each shareholder would have received a capital gain dividend of $1 per share instead of $2 per share.⁷

Generally, ordinary income dividends and capital gain dividends declared for the prior REIT tax year are included in income by the shareholder in the year they are received.⁸ However, any dividend declared by a REIT in October, November, or December of any calendar year and payable to shareholders on a specified date in such a month is treated as received by the shareholder on December 31 of that calendar year so long as the dividend is actually paid during January of the following calendar year.⁹

A REIT may declare but retain a capital gain dividend. If it does so, the REIT must notify its shareholders of the amount of the undistributed dividend and, prior to 2018, pay federal income tax on the undistributed amount at the corporate alternative capital gains rate, which was 35 percent.¹⁰ The corporate AMT was eliminated for tax years beginning after 2017.

A shareholder who is notified of an undistributed capital gain dividend is required to include the dividend in computing his or her long-term capital gains for the taxable year that includes the last day of the REIT’s taxable year. However, the shareholder is credited or allowed a refund for the share of the tax paid by the REIT on the undistributed amount; thus, on the shareholder’s income tax return he or she is treated as though the shareholder made an advance payment of tax equal to 21 percent (the rate was reduced from 35 percent to 21 percent for tax years beginning after 2017) of the amount of the undistributed dividend reported.¹¹ The adjusted basis of a shareholder’s shares in a REIT is increased by the difference between the amount of the undistributed capital gain dividend and the tax deemed paid by the shareholder in respect of such shares.¹²