Many real estate investment trust (REIT) stocks have histories of excellent dividend payments. The tax rules governing REITs promote the payout of profits to investors in the form of dividends. Those same rules mean that investors must pay taxes on those dividends, even if they are reinvested into more REIT shares.
REITs are companies that invest in or own commercial real estate or mortgages. The companies are formed under special tax rules and must follow those rules to maintain the REIT status. A REIT does not pay any corporate income taxes if it passes along at least 90 percent of net earnings to shareholders as dividends. The combination of no taxes at the company level plus the requirement to pay out most of the earnings result in REIT stocks that are attractive income investments from the point of dividend yields.
REIT Dividend Taxes
Regular, non-REIT corporations pay corporate income taxes, so the tax rules have been written so investors receiving dividends from these companies pay a lower tax rate. Tax-advantaged dividends from corporations are referred to as qualified dividends. REIT dividends are not qualified dividends. This means an investor will pay taxes on REIT distributions at her regular tax rate, which will be higher than the tax rate for qualified dividends.
Dividend Reinvestment and Taxes
Many REITs offer dividend reinvestment plans, which allow investors to use dividends to buy more REIT shares. These plans provide a low- or no-cost way to get compound growth from these attractive dividend-paying stocks. However, dividend reinvestment does not avoid or defer taxes on the dividends. A dividend reinvestment plan will send out a Form 1099 at the end of the year listing the dividends earned on the REIT shares in the plan. Those dividends must be included on the investor's tax return and the taxes paid.
REITs and IRAs
Buying REIT shares through an individual retirement account is a way to defer the taxes on the REIT dividends. IRA rules allow earnings in an account to grow untaxed until withdrawals are made in retirement. With a Roth IRA, the earnings — such as REIT dividends — can grow tax-free. Some stockbrokers will reinvest dividends into more shares at no charge, allowing you to also get the benefits of dividend reinvestment.
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