How REIT Dividends Are Taxed Differently Than Stock Dividends

REIT dividends are taxed as ordinary income, not as capital gains

When you receive a dividend from a REIT, the IRS treats it as ordinary income — the same tax bracket as your salary or interest from a savings account. This is the single biggest tax difference between REITs and stocks. If you own shares of Apple or Coca-Cola and receive a dividend, that dividend may may have access to as a "may have access to dividend" taxed at the lower capital gains rate (0%, 15%, or 20%, depending on your income). REIT dividends do not get this break. They are taxed at your full ordinary income tax rate, which can be as high as 37% at the federal level.

This matters most if you hold REITs in a regular taxable brokerage account. A REIT that pays 4% in annual dividends will cost you more in taxes than a stock paying the same 4%, because the REIT dividend hits your ordinary income rate while the stock dividend may hit your capital gains rate. The difference can be substantial — potentially 15 to 20 percentage points in federal tax alone, depending on your tax bracket.

Key Takeaways

• REIT dividends are taxed as ordinary income at your full tax rate, while may have access to stock dividends may be taxed at the lower capital gains rate of 0%, 15%, or 20%.
• Some REIT dividends may include a small portion of return of capital, which is not taxed in the year received but reduces your cost basis instead.
• Holding REITs inside a tax-deferred account like a 401(k) or traditional IRA eliminates the tax on dividends until you withdraw money.
• You will receive a Form 1099-DIV each January showing how much of your REIT dividend was ordinary income and how much (if any) was return of capital.
• The tax hit from REIT dividends is one reason many investors hold REITs in retirement accounts rather than taxable accounts.

Why REITs must distribute most of their income as dividends

REITs are required by law to distribute at least 90% of their taxable income to shareholders each year. In exchange, the REIT itself pays no corporate income tax — the tax burden falls entirely on you, the shareholder. This is the trade-off: REITs avoid the double taxation that regular corporations face (tax at the company level, then tax again when you receive a dividend), but the cost is that you pay ordinary income tax on the full dividend amount.

Because of this requirement, REITs tend to pay higher dividends than stocks do. A typical stock might pay 1% to 2% annually; a REIT might pay 3% to 5%. That higher payout is attractive for income, but it also means a larger tax bill each year if you hold the REIT in a taxable account.

How return of capital affects your tax bill

Not all of a REIT dividend is always ordinary income. Some REITs distribute a portion as return of capital, which is money that comes from the REIT's accumulated reserves rather than from current earnings. Return of capital is not taxed in the year you receive it. Instead, it reduces your cost basis — the original price you paid for the shares.

For example, if you bought a REIT share for $100 and receive a $3 dividend that includes $1 of return of capital, you pay tax only on the $2 of ordinary income. The $1 return of capital lowers your cost basis to $99. When you eventually sell the share, you will owe capital gains tax on the difference between your sale price and your new cost basis of $99 (not $100).

Return of capital is common among REITs that have been paying out more than they earn in the current year, or that are returning accumulated cash to shareholders. Your Form 1099-DIV will break down how much of your dividend was ordinary income and how much was return of capital. You must track this carefully, because if you lose the form or forget to adjust your cost basis, you may pay tax twice on the same money.

Holding REITs in tax-deferred accounts

The simplest way to avoid the tax hit from REIT dividends is to hold them inside a tax-deferred account: a traditional IRA, a Roth IRA, a 401(k), or a similar retirement plan. Inside these accounts, dividends are not taxed when you receive them. You can reinvest them and let them compound without any annual tax bill.

In a traditional IRA or 401(k), you will owe ordinary income tax on the money when you withdraw it in retirement. In a Roth IRA, you owe no tax on withdrawals at all, as long as you follow the withdrawal rules. Either way, you defer or eliminate the tax on REIT dividends, which makes these accounts ideal for holding high-dividend investments.

Many financial advisors suggest holding REITs in retirement accounts and holding stocks (especially those with may have access to dividends or low turnover) in taxable accounts. This is called tax-location strategy — putting each type of investment where it will face the lowest tax burden.

Capital gains tax when you sell REIT shares

When you sell a REIT share, you owe capital gains tax on the profit (or you can claim a loss). The tax rate depends on how long you held the share. If you held it for more than one year, you pay the long-term capital gains rate (0%, 15%, or 20%). If you held it for one year or less, you pay your ordinary income tax rate.

This is the same as with stocks. The difference is that with REITs, you have already paid ordinary income tax on the dividends along the way, so the capital gains tax is on top of that. With stocks paying may have access to dividends, you may have paid a lower tax rate on the dividends, so the total tax burden is often lower even though the capital gains tax rate is the same.

If you received any return of capital, remember that it reduced your cost basis. Your capital gain will be larger than it would have been if you had not received that return of capital. This is not double taxation — the return of capital was not taxed when you received it — but it does mean you owe capital gains tax on money you already received as a distribution.

State and local taxes on REIT dividends

In addition to federal income tax, most states tax REIT dividends as ordinary income. A few states (including Florida, Texas, and Wyoming) have no state income tax at all. Others tax dividends at a lower rate than wages, or exempt certain types of investment income. Your state tax bill on REIT dividends depends on where you live and your state's tax code.

If you live in a high-tax state and hold a high-dividend REIT in a taxable account, the combined federal and state tax on your dividends can exceed 50% in some cases. This is another reason why tax-deferred accounts are popular for REIT holdings.

Tracking REIT taxes across multiple accounts

If you hold the same REIT in both a taxable account and a retirement account, keep careful records of which shares are in which account. Your brokerage will send you a Form 1099-DIV for the taxable account only — not for the retirement account. You need to report the taxable dividends on your tax return, but not the retirement account dividends (until you withdraw from the retirement account).

If you own shares of the same REIT at different brokerages, each brokerage will send you a separate 1099-DIV. Add them together when you file your tax return. If you buy and sell REIT shares during the year, your cost basis tracking becomes more complex, especially if you use a strategy like "sell the highest-cost shares first" to minimize gains. Many brokerages offer cost basis tracking tools, but you should verify their calculations before you file.

Frequently Asked Questions

Can I deduct REIT losses against my other income?

If you sell a REIT share at a loss, you can use that loss to offset capital gains from other investments. If your losses exceed your gains, you can deduct up to $3,000 of the excess loss against ordinary income in a single year. Any remaining losses carry forward to future years. This is the same rule that applies to stock losses.

What if my REIT dividend includes a special distribution?

Some REITs pay special or extra dividends in addition to their regular quarterly dividend. These are taxed the same way as regular dividends — as ordinary income, or partly as return of capital if the REIT specifies. Your 1099-DIV will show the breakdown. Special distributions are often larger than regular dividends and can create a bigger tax bill in that year.

Do I owe tax on REIT dividends I reinvest?

Yes. Whether you take the dividend as cash or reinvest it automatically, you owe tax on it in the year you receive it. Reinvesting does not defer the tax. This is true for both taxable and retirement accounts, though in a retirement account the tax is deferred until withdrawal.

Is there a tax advantage to holding foreign REITs?

Foreign REITs are generally taxed the same way as U.S. REITs — as ordinary income. Some foreign countries withhold tax on dividends paid to U.S. investors, which you may be able to claim as a foreign tax credit on your U.S. return. The rules vary by country and by the specific REIT, so consult a tax professional if you hold foreign REITs.

What happens to REIT taxes if I inherit shares?

When you inherit REIT shares, your cost basis is "stepped up" to the market value on the date of death. This means you owe no capital gains tax on the appreciation that happened before you inherited the shares. You will owe ordinary income tax on dividends going forward, just as any other REIT holder would. This is one tax advantage of inherited investments.