Are REIT Dividends Qualified? Tax Treatment Explained

Most REIT dividends are not qualified dividends. The majority of distributions from Real Estate Investment Trusts are taxed as ordinary income at your marginal federal tax rate, which can be as high as 37%. This is because REITs are structured as pass-through entities — they generally do not pay corporate income tax, so their distributions do not meet the criteria for qualified dividend treatment. However, the Section 199A deduction softens this blow by allowing a 20% deduction on the ordinary income portion of REIT dividends.

Why REIT Dividends Do Not Qualify

To understand why, you need to know what makes a dividend "qualified." Under IRC Section 1(h)(11), a qualified dividend must be paid by a U.S. corporation (or qualified foreign corporation) that has already paid corporate income tax on its earnings. The lower tax rate on qualified dividends (0%, 15%, or 20%) is essentially the government's way of offsetting the double taxation that occurs when earnings are taxed at the corporate level and then again at the individual level.

REITs, however, are designed to avoid corporate-level taxation. By distributing at least 90% of their taxable income to shareholders, REITs can deduct those distributions and pay little or no corporate income tax. Since the income was never taxed at the corporate level, there is no double taxation to offset, and the preferential qualified dividend rate does not apply.

This means that when Realty Income (O) pays its monthly dividend, the ordinary income portion is taxed at your full marginal rate — the same rate as your salary, wages, or interest income.

The Components of REIT Distributions

Not all of a REIT dividend is ordinary income. REIT distributions typically consist of several components, each with different tax treatment:

Component	Tax Treatment	Typical Portion
Ordinary income	Marginal tax rate (199A deduction applies)	60% – 90%
Capital gains	Long-term capital gains rate (0%/15%/20%)	5% – 25%
Return of capital	Not taxable (reduces cost basis)	0% – 30%
Qualified dividends	Qualified dividend rate (0%/15%/20%)	0% – 10%

The qualified dividend portion of REIT distributions is typically small and comes from income the REIT earned from taxable REIT subsidiaries (TRS) or from qualified dividends the REIT itself received from stock investments. Some REITs like Simon Property Group (SPG) have historically had a modest qualified dividend component.

How Section 199A Helps REIT Investors

The Section 199A qualified business income deduction is a significant benefit for REIT investors holding shares in taxable accounts. The ordinary income portion of REIT dividends qualifies for a 20% deduction, reducing the effective federal tax rate. For someone in the 37% bracket, the effective rate drops to approximately 29.6%.

The Section 199A deduction for REIT dividends has no income limitation, unlike the QBI deduction for certain service businesses. Whether you earn $50,000 or $5 million, you can deduct 20% of your qualified REIT dividends (reported in Box 5 of Form 1099-DIV).

While 29.6% is still higher than the 20% maximum qualified dividend rate, it is a meaningful improvement over the full 37% that would otherwise apply. Combined with the return of capital and capital gains components that many REITs distribute, the blended effective tax rate on REIT distributions can be quite reasonable.

Holding Period for REIT Dividends

Even though most REIT dividends are not qualified, there is still a holding period requirement for the Section 199A deduction. You must hold REIT shares for more than 45 days during the 91-day period beginning 45 days before the ex-dividend date. If you fail this requirement, the dividends are not eligible for the 199A deduction.

For the small portion of REIT dividends that are classified as qualified dividends, the standard qualified dividend holding period applies: more than 60 days during the 121-day period surrounding the ex-dividend date.

Best Account Placement for REITs

Because REIT dividends are predominantly ordinary income, they are among the least tax-efficient investments to hold in a taxable account. Conventional wisdom recommends holding REITs in tax-advantaged accounts:

• Roth IRA: The ideal location. REIT dividends grow and compound tax-free, and qualified withdrawals are tax-free.
• Traditional IRA or 401(k): Dividends are tax-deferred until withdrawal, at which point they are taxed as ordinary income regardless of their original character.
• Taxable account: Least efficient, but the 199A deduction helps. This is acceptable if your tax-advantaged space is full or if you need the income for current expenses.

Note that if you hold REITs in a traditional IRA, you lose the benefit of the Section 199A deduction because all withdrawals from a traditional IRA are taxed as ordinary income regardless of the source. This is one argument for prioritizing Roth IRAs for REIT holdings.