How a REIT works
A REIT lets you own a slice of large, income-producing properties without buying or managing a building. It collects rent or mortgage interest, pays its costs and distributes most of what is left. Unlike a developer, it buys and develops properties mainly to operate them, not to resell them.
The tax treatment is what makes the structure work. An ordinary corporation pays corporate income tax, and its shareholders are taxed again on the dividends. A REIT deducts the dividends it pays, so income it distributes is taxed once, in shareholders’ hands, as long as it follows strict rules on what it owns, where its income comes from and how much it pays out.
Equity REITs own properties such as apartments, office buildings, shopping malls, hotels, self-storage facilities and warehouses. Mortgage REITs hold real estate loans and earn interest, so their results depend heavily on interest rates and borrowing costs. Individual investors usually hold REITs in one of three ways:
- Publicly traded REITs: listed on a stock exchange, bought through any broker and priced every trading day.
- REIT mutual funds and ETFs: many REITs in one holding. A broad US stock index fund may already hold listed REITs.
- Non-traded REITs: registered with the SEC but not listed, sold through brokers or advisers that take part in the offering, and hard to sell.
Rules a company must meet to be a REIT
The requirements are in sections 856 and 857 of the Internal Revenue Code. A company elects REIT status on its tax return and must keep passing the tests, some of them every quarter; failing them can cost it the deduction for dividends paid. Because most of its earnings must go out as dividends, a REIT usually grows by raising new money from investors or lenders rather than by reinvesting profits. The main tests:
- Payout: dividends paid must equal at least 90% of REIT taxable income, figured before the dividends-paid deduction and excluding net capital gain.
- Assets: at the close of each quarter, at least 75% of total assets in real estate, cash and cash items, and government securities.
- Income: at least 75% of gross income from real estate sources such as rents and mortgage interest, and at least 95% from those sources plus other dividends, interest and securities gains.
- Ownership: at least 100 shareholders, and five or fewer individuals can’t own more than 50% of the value at any time in the last half of the tax year.
- Subsidiaries: securities of taxable REIT subsidiaries can’t exceed 25% of total assets, up from 20% for tax years beginning after December 31, 2025.
- Structure: managed by trustees or directors, with transferable shares, and not a bank or insurance company.
How REIT dividends are taxed in 2026
REIT payouts usually arrive as a mix, and Form 1099-DIV sorts it into boxes.
Most of a typical payout is ordinary dividends that are not qualified dividends, because the REIT paid no corporate tax on that income. They are taxed at ordinary rates, but the part reported in box 5 as section 199A dividends qualifies for a deduction of 20% of the amount. The One Big Beautiful Bill Act removed the provision that would have ended the deduction after 2025, so it continues in 2026 and later. At the top 37% rate the deduction cuts the effective rate to 29.6% (37% × 0.8). You must hold the shares more than 45 days during the 91-day period that starts 45 days before the ex-dividend date. The deduction is available whether or not you itemize, but it lowers taxable income, not adjusted gross income.
Capital gain distributions, box 2a, are long-term capital gains however long you held the shares, though the part in box 2b, unrecaptured section 1250 gain from depreciation, is taxed at up to 25%. Nondividend distributions, box 3, are a return of capital: not taxed when paid, but they reduce your cost basis and so raise your gain when you sell. A REIT can also designate a small part of a payout as qualified dividends. The 3.8% net investment income tax can apply to the taxable parts.
REITs vs. owning rental property
Both give you real estate income, but the work and the tax picture differ sharply. Owning a rental directly gives you control, the choice of mortgage leverage and depreciation deductions that can shelter part of the rent, plus the option to defer gain on a sale with a 1031 exchange. It also brings tenants, repairs, concentration in one or two properties and a sale that can take months.
A REIT is close to the reverse. You can sell listed shares on any trading day, the money is spread across many properties, and someone else handles the tenants. But the depreciation stays inside the REIT, REIT losses never flow through to your return, and REIT shares are stock, not real property, so they can’t be swapped in a 1031 exchange. Listed REIT prices also move daily with the stock market, while a building you own is valued only when it is appraised or sold.
Non-traded REITs carry extra risks
Non-traded REITs are registered with the SEC but don’t trade on an exchange, and the SEC’s investor education office warns that this creates special risks. They are typically sold by a broker or financial adviser, and their yields can look higher than those of listed REITs. But a distribution paid from borrowed money or new investors’ cash isn’t income the properties earned, and it can leave the shares worth less. Before buying one, weigh the risks the SEC’s investor site points out:
- Liquidity: the shares generally can’t be sold readily, so you may not be able to raise cash from them quickly.
- Value: with no market price, the per-share value on your statement is only an estimate, and it can be hard to know what the shares are really worth.
- Distributions: they frequently pay more than their funds from operations, using offering proceeds and borrowing, which reduces share value.
- Fees: sales commissions and up-front offering fees usually total about 9% to 10% of the investment.
- Conflicts: they typically have an external manager paid fees based on acquisitions and assets under management, which may not align with shareholders’ interests.
Illustrative numbers
$10,000 of REIT distributions for a single filer in the 24% bracket, 2026
Section 199A dividends (box 5), holding period met$7,000 × 24% = $1,680
Less the 20% deduction: $1,400 × 24%−$336
Capital gain distribution (box 2a) at 15%$1,000 × 15% = $150
Return of capital (box 3), no tax now$2,000 off your cost basis
Federal income tax on the $10,000$1,680 − $336 + $150 = $1,494
About 14.9% of the payout went to federal income tax, and the box 5 dividends were taxed at an effective 19.2% instead of 24%. The $2,000 return of capital is deferred, not tax-free: it lowers basis and shows up as extra gain when you sell. In a traditional IRA, nothing is taxed until withdrawal, when all of it becomes ordinary income.
At a glance
Listed REIT shares vs. owning a rental property directly
| Feature | Listed REIT or REIT fund | Direct rental property |
|---|---|---|
| Selling | Any trading day | Weeks or months, with selling costs |
| Diversification | Many properties, often several property types | Usually one or a few properties |
| Work required | None | Tenants, repairs and bookkeeping, or a manager’s fee |
| Depreciation | Stays inside the REIT | Yours to deduct; the gain it creates is taxed at up to 25% on sale |
| Tax on income | Mostly ordinary dividends, with a 20% section 199A deduction | Net rent after expenses and depreciation, on Schedule E |
| 1031 exchange | Not available for shares | Available for real property held for investment |
Put it in your plan
REIT in MoneyWhatIf
In MoneyWhatIf, REIT shares or a REIT fund belong inside an investment account, which can follow the plan’s shared growth and dividend assumptions or use its own rates. In a taxable account, dividends are split between the selected qualified share and ordinary income, while tax-sheltered accounts follow their account kind’s treatment. A building you own directly is different: give it a property card and enable rent, and the model builds its taxable rental profit from that property’s own rent, deductible costs and depreciation.
Common questions
REIT FAQs
Why do REITs pay such high dividends?
Because the tax rules require it. To keep its status, a REIT must pay dividends equal to at least 90% of its taxable income, and paying them out lets it avoid corporate income tax on that income. A high yield doesn’t mean a higher total return, though: the price of the shares can fall even while the dividends keep coming.
Should REITs be held in an IRA or a taxable account?
There are trade-offs rather than one answer. A traditional IRA or Roth account shelters the ordinary-income dividends from annual tax, which is why REITs often appear in tax-deferred accounts. A taxable account keeps the 20% section 199A deduction and the deferral from return-of-capital distributions, and lets you harvest losses, but you pay tax every year on most of the income.
Can you lose money in a REIT?
Yes. Listed REIT shares move with the stock market and with interest rates, and they can fall sharply in a downturn. A REIT can cut its dividend if rents or occupancy drop, and mortgage REITs are exposed to borrowing costs and loan defaults. Non-traded REITs add the risk of being unable to sell and of distributions funded by borrowing.
How can I check a REIT before investing?
Start by confirming it is registered with the SEC; the SEC’s investor site warns against anyone selling REITs that aren’t. Its EDGAR database lets you verify registration for listed and non-traded REITs and read their annual and quarterly reports and any offering prospectus. Check the background of the broker or adviser recommending it, too. For a non-traded REIT, look closely at the up-front fees and at whether distributions exceed funds from operations.