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

When you receive a dividend from a real estate investment trust (REIT), the IRS treats it differently than dividends from regular corporations. Most REIT dividends are taxed at your ordinary income tax rate — the same rate you pay on wages or salary. This means they are taxed more heavily than may have access to dividends from stocks, which get preferential capital gains rates.

The reason is structural: REITs are required by law to distribute at least 90 percent of their taxable income to shareholders. Because of this pass-through structure, the tax burden flows to you rather than being paid at the corporate level. The dividend you receive is considered ordinary income in the eyes of the IRS, regardless of whether the REIT's underlying assets gained value.

This matters most if you are in a higher tax bracket. A may have access to stock dividend taxed at 15 or 20 percent could be taxed at 37 percent if it came from a REIT and you are in the top bracket. Over time, this difference compounds significantly in taxable accounts.

Key Takeaways

  • REIT dividends are taxed as ordinary income at your full marginal tax rate, not at the preferential capital gains rates that apply to most stock dividends.
  • A portion of your REIT dividend may be classified as a return of capital, which is not taxed in the year received but reduces your cost basis instead.
  • If you hold a REIT in a tax-deferred account like an IRA or 401(k), the tax treatment does not matter because the account itself is tax-sheltered.
  • You will receive a Form 1099-DIV in January showing how much of your REIT dividend is ordinary income, capital gains, and return of capital.
  • Holding REITs in taxable accounts costs more in taxes than holding them in retirement accounts, so account placement strategy matters.

The three components of a REIT dividend and how each is taxed

A single REIT dividend payment can contain three different types of income, and each is taxed differently. The REIT will break this down for you on Form 1099-DIV, which arrives in January. Understanding these categories helps you know what tax bill to expect.

Ordinary income is the largest portion for most REITs. This is taxed at your full marginal rate — whatever bracket you fall into. If you earn $100,000 and are in the 24 percent bracket, ordinary REIT income is taxed at 24 percent. This is the core reason REIT dividends carry a higher tax cost than stock dividends.

Capital gains are the second component. If the REIT sold properties or securities at a profit, it must pass those gains to you. These are taxed at capital gains rates — 0, 15, or 20 percent depending on your income level — which is lower than ordinary income rates. However, most REIT dividends are not primarily capital gains; they are mostly ordinary income.

Return of capital is the third piece. This is not actually income — it is a return of part of your original investment. It is not taxed in the year you receive it, but it reduces your cost basis (the price you paid for the shares). When you eventually sell the REIT, your gain will be higher because your basis is lower. The tax is deferred, not eliminated.

Why REIT dividends are taxed as ordinary income

REITs exist under a special tax structure. In exchange for distributing 90 percent or more of taxable income to shareholders, REITs themselves pay no corporate income tax. This is different from a regular corporation, which pays tax first, then distributes what is left as dividends.

Because the REIT does not pay tax at the entity level, the tax responsibility shifts entirely to you. The IRS considers the income you receive to be ordinary business income from real estate operations — rent, interest, and property management fees. These are ordinary income sources, not investment gains, so they are taxed at ordinary rates.

This structure benefits REIT investors in one way: you are not double-taxed. A regular corporation pays 21 percent corporate tax, then you pay tax again on the dividend. A REIT avoids the first layer of tax. But because all the tax lands on you at once, and at ordinary rates, the total tax can still be higher than owning stocks that pay may have access to dividends.

How tax-deferred accounts change the equation

If you hold a REIT inside a traditional IRA, Roth IRA, 401(k), or other tax-deferred account, the tax treatment of the dividend does not matter. The account itself is tax-sheltered, so you pay no tax on the dividend in the year you receive it. This is one of the strongest reasons to hold REITs in retirement accounts rather than in taxable brokerage accounts.

In a traditional IRA or 401(k), the dividend compounds tax-free until you withdraw money in retirement. In a Roth IRA, the dividend and all growth are never taxed, as long as you follow withdrawal rules. The ordinary income classification becomes irrelevant because the account wrapper shields you from annual tax bills.

This is why financial advisors often recommend placing tax-inefficient investments — like REITs, bonds, and actively managed funds — in retirement accounts, and holding tax-efficient investments like index funds in taxable accounts. It is a form of tax-location strategy.

What Form 1099-DIV tells you and when you receive it

Every January, your REIT (or the brokerage holding it for you) sends you a Form 1099-DIV. This form breaks down exactly how much of your dividend is ordinary income, capital gains, and return of capital. You use these numbers to fill out your tax return.

Box 1a on the form shows ordinary dividends. Box 2a shows long-term capital gains. Box 3 shows nondividend distributions, which is the return of capital portion. Some REITs also report foreign taxes paid or unrecaptured Section 1250 gains, which have their own tax treatment.

If you own the REIT through a brokerage, the brokerage will send you the 1099-DIV. If you own it directly through the REIT's transfer agent, the REIT sends it to you. Either way, you should receive it by January 31. If you do not receive it by mid-February, contact the issuer or your brokerage.

Comparing REIT tax treatment to stock dividends and bonds

The tax difference between REITs and stocks is substantial. A stock dividend that qualifies for preferential treatment is taxed at 0, 15, or 20 percent depending on your income. A REIT dividend is taxed at your ordinary rate, which ranges from 10 to 37 percent. For a high-income investor, this is a 17 to 37 percentage point difference on the same dollar amount.

Bonds are taxed similarly to REIT ordinary income — at ordinary rates. This is why both REITs and bonds belong in tax-deferred accounts if you have the space. If you must hold them in taxable accounts, the tax drag reduces your after-tax return significantly over time.

Growth stocks that do not pay dividends are the most tax-efficient for taxable accounts because you pay no tax until you sell, and then only on gains. Index funds that track the market are also relatively tax-efficient because they have low turnover. REITs, by contrast, are tax-inefficient in taxable accounts by design.

State and local taxes on REIT dividends

In addition to federal income tax, most states tax REIT dividends as ordinary income. The state rate varies widely — from 0 percent in states with no income tax to over 13 percent in high-tax states. Some states offer preferential rates for capital gains but not for ordinary dividends, which widens the gap further.

A few states have special rules. Some exempt certain types of investment income or offer credits for taxes paid to other states. If you live in a state with high income tax and hold REITs in a taxable account, the combined federal and state tax burden can exceed 40 percent of the dividend.

This is another reason to prioritize placing REITs in tax-deferred accounts. The state tax savings alone can be significant over decades of holding.

Frequently Asked Questions

Can I deduct REIT losses against other income?

If you sell a REIT at a loss, you can deduct that loss against capital gains from other investments. If you have no capital gains, you can deduct up to $3,000 of losses against ordinary income in a single year, with the remainder carried forward to future years. This is the same rule that applies to all investment losses.

Is the return of capital portion of a REIT dividend ever taxed?

Yes, but not immediately. Return of capital reduces your cost basis in the REIT. When you sell the shares, your taxable gain is higher because your basis is lower. The tax is deferred until the sale, and it is taxed as a capital gain at that time, not as ordinary income.

Do I owe taxes on REIT dividends if I reinvest them?

Yes. Reinvesting the dividend does not change the tax treatment. You owe tax on the full dividend amount in the year you receive it, whether you take the cash or use it to buy more shares. The reinvestment is a separate transaction from the dividend itself.

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 start fresh with no built-in gain. You owe tax only on dividends going forward and on any gains above the stepped-up basis. This is a significant tax benefit of inheritance.

Are foreign REITs taxed differently?

Foreign REITs are taxed based on where they are domiciled and the tax treaty between that country and the United States. Some foreign REIT dividends may be subject to withholding tax. The tax treatment is complex and varies by country, so consult a tax professional if you hold international REITs.