Real Estate Investment Trusts (REITs) present a streamlined and tax-efficient method for investing in real estate. They allow investors to access diversified portfolios without the challenges of direct property management. By aggregating investor funds to own, operate, or finance assets such as apartments, offices, warehouses, or healthcare facilities, REITs generate passive income and offer significant tax advantages. This article delves into how REITs function, the updated tax benefits for 2025 under the One Big Beautiful Bill Act (OBBBA), their effects on commercial property owners, strategies, and a case study—all while highlighting how these vehicles enhance tax planning in the post-2025 environment.
REIT Requirements by the IRS:
- Distribute 90% of taxable income as dividends,
- Invest at least 75% of assets in real estate or related assets,
- Generate 75% of revenue from real estate sources,
- Have a minimum of 100 shareholders, and
- Be organized as a corporation or trust.
REITs fall into several categories: equity REITs (which own property through rental income), mortgage REITs (which earn interest from debt), and hybrid REITs (a combination of both). Most are publicly traded, offering stock-like liquidity and avoiding corporate taxes by directing income to shareholders, who are taxed individually. Non-traded options exist, but they generally incur higher fees and offer less liquidity.
The primary tax benefits arise from this pass-through model, which circumvents the double taxation often associated with traditional corporations. Dividends comprise ordinary income (taxed up to 37%, but now eligible for the permanent 20% QBI deduction under OBBBA, effectively lowering rates to 29.6% for top brackets), capital gains (ranging from 0-20% plus a 3.8% NIIT for high earners), and ROC (tax-deferred, reducing basis until sale). The QBI deduction, initially set to expire after 2025, has now been made permanent, with increased phase-ins ($75,000 for singles and $150,000 for joint filers) and a $400 inflation-adjusted minimum for those with at least $1,000 in qualifying income.
Example: A $50,000 dividend (comprising 70% ordinary income and 30% gains) taxed at 37% and 15% rates results in $12,950 in taxes, compared to $18,500 if all were ordinary income—QBI further reduces the ordinary portion.
REITs help avoid common ownership issues such as lengthy depreciation schedules, 25% recapture on sales, and extensive expense tracking, simplifying reporting with Form 1099-DIV. Diversification across various sectors and regions mitigates risks, while liquidity aids in tax-loss harvesting. The OBBBA's 2025 updates reinforce these benefits: TRS asset limits increase from 20% to 25% (effective 2026), allowing for more subsidiary activities; Section 163(j) interest deductions revert to EBITDA-based calculations for improved deductibility; and 100% bonus depreciation becomes permanent, enhancing cash flow.
For commercial property owners, REITs offer simplified tax reporting, eliminating the need for cost segregation or 1031 exchanges, along with stable yields of 3-6%, flexible components, and reduced single-asset risk. Trade-offs include less control, absence of 1031 deferrals, and potentially capped appreciation compared to value-add strategies. To maximize efficiency, consider the following strategies:
- Analyze 1099-DIV breakdowns for informed planning.
- Prefer REITs with high returns on capital (ROC).
- Incorporate REITs into IRAs for tax deferral or use losses in taxable accounts.
- Diversify with ETFs.
- Monitor reforms like QBI permanence.
- Compare performance between public and non-traded options.
Case Study
An owner sells a $3M building with a $1M gain and subsequently invests $1M in a 4% equity REIT (comprising 60% ordinary income, 20% gains, and 20% ROC). The resulting annual $40,000 dividends are taxed at $8,304 after QBI, in contrast to $14,800 without it, yielding an annual savings of $6,496. Over the course of 10 years, this equates to $400,000 in dividends and approximately $65,000 in savings, alongside the benefits of diversification.
REIT Type Comparison
REITs excel in tax efficiency through pass-through income, enhanced QBI benefits, and OBBBA advantages, such as TRS expansion and bonus depreciation, providing reliable income amid stable capital gains rates. While they lack direct control, their simplicity and diversification make them a robust option for wealth building—seeking advice from professionals for personalized guidance is recommended.