REIT dividends come in several different types, which have different tax rates. Since Real Estate Investment Trusts, or REITs, are set up in a variety of ways, it makes sense that REIT dividends will be split up into several categories. Looking at different REIT dividends will help investors make sense of the gains and yields that they can expect from these specialized financial products.
REITs are a specific kind of opportunity for investing in real estate. The government has provided regulations for REITs in order to make sure that they function the way they are supposed to. One of these rules is that the REIT must distribute the majority of its current income through dividends.
The three primary classes of REIT dividends are a “return of capital,” a “capital gain,” and an ordinary dividend. The return of capital doesn’t generally carry a tax rate. Experts describe this as a return of the investor’s own investment, where there might be some tax burden down the road depending on related sale events. There’s also capital gain, which occurs when the REIT sells assets, and the capital gains are taxed at the regular capital gain rates, where there are two rates for short-term and long-term gains.
A common dividend from an REIT, on the other hand, comes from the operation of the trust, often in renting out properties. Here, the gain is subject to a “full marginal tax rate,” which is determined by the investor’s net worth and other factors. REIT dividends can be looked at as part of a larger class of “common dividends” such as those that the investor gets from remaining invested in a particular stock or fund.
Apart from these general categories, the specific nature of an REIT dividend has a lot to do with the general operation of the REIT itself. Different kinds of REITs have very diverse investment strategies, where what the leadership does with its money will determine what kind of dividend gets paid out. A real estate investment trust can focus on buying and/or renting property, buying up mortgages, or trading in some rather abstract mortgage securities. All of these different strategies should be listed on the prospectus, which is what the investor looks at to determine relative benefit and risk before buying into the fund. Investors can analyze diversified REITs as well as specific “flavors” of funds like commercial, retail or residential REITs to figure out which ones are best suited to their particular investment strategy.