A real estate investment trust (REIT) is a corporation or trust that purchases and manages income property and/or mortgage loans. REITs were created by the U.S. Congress in 1960, with the intention of making large-scale, income-producing real estate accessible to small investors.
REITs are similar to traditional stocks in that the securities are traded on major exchanges. However, unlike a company that manufactures, markets or distributes goods or services to customers, a REIT owns and operates income-producing real estate, such as apartments, shopping centers, offices, hotels and warehouses.
REITs are traded on an exchange and can be purchased and sold through a broker. Shares are listed on the New York, American and NASDAQ stock exchanges as well as some over-the-counter markets. REITS must follow all of the rules of the stock exchange as well as file quarterly and annual financial statements with the SEC.
Like publicly traded companies, the corporate officers who manage the REITs are accountable to creditors and shareholders as well as a board of directors that is elected by shareholders.
As with traditional stocks, shareholders gain investment value in REITs in the form of share price appreciation and dividend payments. Dividends are traditionally very high because a REIT is required by law to distribute 90% of its taxable income to shareholders each year in the form of dividends. Most of the income from a REIT is from rent and other earnings that do not qualify for the lower tax rates; therefore, most of the distribution to shareholders is taxed at ordinary income tax rates.
There are three major types of REITs:
Shares of a REIT can be purchased through a broker. In addition, some REITs offer direct stock purchase and dividend reinvestment programs. Also, a variety of closed-end and non-exchange-traded REITs exist.
In addition to buying individual REITs, you can also invest in a diversified portfolio of REITs through mutual funds and exchange-traded funds that focus on REITs.
Any investor looking to add real estate to a portfolio for diversification purposes may find REITs an attractive option. There are over 150 individual REITs to choose from and a variety of mutual funds that specialize in REITs.
Because REITs have such high dividend payouts that are not subject to the lower qualified dividend tax rate, this investment may be better suited for a tax-sheltered account such as an IRA, a Roth IRA or a 401(k). However, some investors have found a lack of REIT investment choices available through typical 401(k) plan offerings.
Because REITs must distribute at least 90% of their taxable income to shareholders annually, shareholders will have to pay taxes on dividends received in any account that is not tax-sheltered. In addition, REIT dividends are taxed as ordinary income; the lower tax rates available for qualified dividends do not apply to REIT dividends.
Distributions are allocated as ordinary income, capital gains and return of capital. Each of these distribution classifications has different tax rules and rates. The REIT will provide shareholders with a Form 1099-DIV each year detailing how the distributions have been classified for tax purposes. A return of capital distribution is not taxed as ordinary income, but reduces the shareholder's cost basis of the investment by the amount of the distribution.
When shares are sold, any capital gains are taxed.
National Association of Real Estate Investment Trusts
www.reit.com
The National Association of Real Estate Investment Trusts (NAREIT) is the trade organization for real estate firms. The site offers performance and industry data as well as links to other helpful sites.