Tax Benefits of a REIT

Under the Tax Cuts and Jobs Act (“TCJA”), the use of REITs has the ability to provide significant tax benefits not only for tax- exempt and foreign investors, but also for US-based investors.

REITs as a Blocker of Unrelated Business Taxable Income (UBTI) and Effectively Connected Income (ECI) with a US Trade or Business

Tax-exempt investors are subject to tax on UBTI. Real estate rental income is generally excluded from UBTI; however, there is a major exception when real estate is financed with debt. Debt-financed income is generally subject to UBTI tax (an exception exists for certain qualified organizations). A REIT transforms rental income into dividends which are not treated as UBTI.

Section 199A Qualified Business Income 20% Deduction

One such benefit is Section 199A under the TCJA, which allows taxpayers a 20% deduction against certain types of qualified business income but is subject to wage and/or basis limitations. REIT dividends are also eligible for the 20% deduction but are not subject to the wage and/or basis limitations.

State Filings

A REIT files state tax returns for the states where the real estate is held. The dividends that are reported to US-based investors are generally only taxable in an investor’s resident state, so this eliminates the need for multiple state tax filings at the investor level as well as the onerous tax-withholding requirements.

Compliance Timing and Costs

A REIT only reports dividends to its shareholders (i.e. the fund partnership), and the determination of whether there are taxable dividends is made at the beginning of the year; therefore, the fund partnership return, along with investor K-1s, can be prepared and distributed in a timely manner.

As the only activity flowing to investors consists of dividend income and tax withholding is not required on behalf of the investors, the investors themselves may recognize compliance cost savings as a result of filing in less states.