Creating a REIT requires meeting strict IRS rules about ownership, income sources, and distributions

A REIT is a corporation, trust, or partnership that must follow specific federal requirements to exist as one. You cannot simply declare your real estate holdings a REIT; you must structure the entity itself to meet IRS standards, file the right paperwork with your state, and then elect REIT status with the IRS. The process takes months and involves legal documents, tax filings, and ongoing compliance obligations that do not end once you are formed.

Most people who want to invest in real estate through a REIT buy shares in an existing one rather than create their own. Creating a REIT makes sense only if you own substantial commercial or residential property, have multiple investors, and plan to hold and manage those properties long-term while distributing most of the income to shareholders. If you own a single rental house or a small portfolio, a REIT structure is almost certainly not the right choice.

Key Takeaways

  • You must own real estate worth millions of dollars and have at least 100 shareholders to form a REIT that meets IRS requirements.
  • A REIT must distribute at least 90 percent of its taxable income to shareholders each year, which limits how much cash you can retain in the business.
  • You need to file articles of incorporation or trust with your state, then file Form 1120-REIT with the IRS to elect REIT status.
  • A REIT must derive at least 75 percent of its income from real estate sources like rent and property sales, and hold at least 75 percent of its assets in real property.
  • You will need a lawyer experienced in REIT formation and a CPA who understands REIT tax rules, because mistakes in structure or reporting can disqualify you retroactively.

Understand the minimum size and ownership requirements

The IRS does not set a minimum dollar amount of assets, but in practice you need substantial real estate holdings. Most REITs own properties worth $100 million or more, though smaller REITs exist. More important than total value is the number of shareholders: you must have at least 100 shareholders at the end of your first tax year as a REIT, and no more than 50 percent of the shares can be held by five or fewer people.

This ownership structure requirement means you cannot form a REIT with just yourself and a spouse, or even with a small group of friends. You need enough investors that the ownership is genuinely dispersed. If you own a portfolio of rental properties and want to bring in outside capital, a REIT can work. If you want to keep control and ownership within a tight circle, a REIT creates more problems than it solves.

Choose your entity type and file with your state

A REIT can be structured as a corporation, a trust, or a partnership. Most are corporations because the structure is familiar and the tax treatment is clear. You will file articles of incorporation with your state's secretary of state office, just as you would for any corporation. Some states have specific requirements or fees for REITs; check with your state's business filing office before you begin.

The state filing itself does not make you a REIT — it only creates the legal entity. You become a REIT for federal tax purposes only after you file the right IRS forms and meet all the operational requirements. Many people form the entity first, then work with a lawyer and accountant to ensure they meet REIT rules before they elect REIT status with the IRS.

Meet the income and asset composition tests

A REIT must derive at least 75 percent of its gross income from real estate sources. These include rent from tenants, income from property sales, interest on mortgages secured by real property, and certain real estate-related fees. The remaining 25 percent can come from other sources, but there are limits on what counts.

At the same time, at least 75 percent of your total assets must be invested in real property, mortgages, and cash. The other 25 percent can be in stocks, bonds, or other investments, but again with restrictions. These tests are measured at the end of each quarter, so you cannot simply meet them once and then ignore them. If you fall out of compliance, you lose REIT status and face tax penalties.

Set up the distribution requirement in your bylaws

A REIT must distribute at least 90 percent of its taxable income to shareholders each year. This is not optional and not something you can skip in a down year. If you earn $1 million in taxable income, you must pay out at least $900,000 to shareholders, whether as dividends or other distributions. This requirement is why REITs are attractive to income-focused investors but also why they retain little cash for expansion or emergencies.

You will write this distribution requirement into your bylaws or trust document before you file for REIT status. Your board or trustees must then follow it every year. If you fail to distribute enough, you lose REIT status and owe back taxes plus penalties. Many REITs hire a dividend specialist or work closely with their accountant to calculate the exact distribution amount each quarter.

File Form 1120-REIT with the IRS to elect REIT status

Once your entity is formed and you have met the structural requirements, you file Form 1120-REIT (U.S. Income Tax Return for Real Estate Investment Trusts) with the IRS. This form is your election to be taxed as a REIT. You must file it by the tax return deadline for your first year as a REIT, usually April 15 of the following year (or October 15 if you file an extension).

The form itself is complex and requires detailed schedules showing your income sources, asset composition, and shareholder information. Most people do not file this form without a CPA who has REIT experience. Filing it incorrectly can result in the IRS denying your REIT status, which creates a cascade of tax problems for you and your shareholders.

Maintain ongoing compliance and annual reporting

Becoming a REIT is not a one-time filing. Every year you must file Form 1120-REIT, report your income and distributions, and certify that you still meet all the composition tests. You must also file a Form 8288-B if you have foreign shareholders, and you may need to file state tax returns depending on where your properties are located.

You must also maintain detailed records of your shareholder base to prove you meet the 100-shareholder minimum and the five-person ownership cap. If a shareholder dies or sells their shares, you need to track the transaction. If you fail any of these tests at year-end, you lose REIT status retroactively, which means you owe corporate income tax on all the income you thought was flowing through to shareholders, plus penalties and interest.

Work with a lawyer and accountant experienced in REIT formation

The cost of forming a REIT includes legal fees (typically $10,000 to $50,000 or more depending on complexity), accounting fees for the first-year setup and ongoing compliance, and state filing fees. These costs are worth it only if you have a large enough portfolio and investor base to justify them. A lawyer will draft your articles of incorporation or trust document, ensure your bylaws meet IRS requirements, and guide you through the election process. An accountant will help you structure your income and assets to pass the composition tests and will prepare your annual REIT tax return.

Do not attempt to form a REIT without professional help. The IRS rules are detailed and the penalties for mistakes are steep. A lawyer or accountant who has never formed a REIT before is not the right choice either — you need someone with specific REIT experience who can anticipate problems and structure your entity correctly from the start.

Frequently Asked Questions

Can I form a REIT with just my spouse and one other investor?

No. You need at least 100 shareholders by the end of your first tax year, and no more than 50 percent of shares can be held by five or fewer people. A REIT with three shareholders cannot meet these requirements. You would need to bring in many more investors or use a different business structure.

What happens if I fall below 100 shareholders?

If you drop below 100 shareholders at year-end, you lose REIT status for that tax year. You owe corporate income tax on all the income you distributed to shareholders, and you and your shareholders face tax bills and penalties. You can reapply for REIT status in a future year if you rebuild your shareholder base, but the damage is already done.

Do I have to distribute all my income every year?

You must distribute at least 90 percent of taxable income. You can retain up to 10 percent, though most REITs distribute more than 90 percent to stay competitive with other REITs and keep shareholders happy. If you need to retain cash for property improvements or debt paydown, a REIT structure makes that difficult.

Can I own a REIT and also own real estate outside the REIT?

Yes, but the REIT and your personal real estate are separate entities. Income and assets from outside the REIT do not count toward the REIT's composition tests. If you own rental properties outside the REIT, you pay tax on that income separately as an individual or through another business entity.

How long does it take to form a REIT?

State incorporation takes one to four weeks depending on your state. Preparing REIT documents and ensuring compliance with IRS rules typically takes two to four months. You can file your REIT election with the IRS once your entity is formed and you have met the structural requirements, but you cannot claim REIT status until you file Form 1120-REIT for your first tax year.