As 2025 draws to a close, Real Estate Investment Trusts (REITs) and real estate funds face a critical window for tax planning, compliance and strategic decision making. This article distills the latest guidance, compliance requirements and legislative changes, empowering you to optimize your year-end actions and prepare for 2026.
Why Year-End Planning Matters for REITs
- REITs enjoy special tax treatment under the Internal Revenue Code, provided they meet strict organizational, asset, income and distribution requirements.
- Year-end planning is essential to ensure compliance with asset and income tests, meet distribution and filing deadlines, and maximize tax efficiency.
- Failing to plan can result in income and excise taxes or even loss of REIT status.
REIT-Level Taxes: What to Watch For
Even when a REIT meets all the basic requirements and deducts dividend distributions, it can still face entity-level taxes in specific situations, including:
- Prohibited Transactions: If a REIT sells property in the ordinary course of business — such as flipping condos — it faces a 100% tax on the gain from those sales. There are exceptions, but they’re limited. You can apply the safe harbor, but you must carefully plan.
- Foreclosure Property: If a REIT acquires property through loan or lease default and does not meet the 75% income test, net income from that property is taxed at 21%. It is not subject to 100% tax on income from prohibited transactions.
- Insufficient Cash Distributions: A REIT must distribute dividends equal to at least 90% of its taxable income, excluding capital gains, and any income retained is taxed at 21%. If the REIT retains capital gains, the tax it pays on such gains will pass through as a credit to its shareholders. However, if less than 85% of ordinary income and 95% of net capital gain are distributed during the year, a 4% excise tax applies to the undistributed portion. This makes accurate distribution planning crucial.
As a practical matter, most REITs distribute 100% of their taxable income to avoid any corporate level taxes.
REIT Distribution Planning: Rules and Strategies
As mentioned, REITs must distribute at least 90% of taxable income each year to maintain their tax-advantaged status and avoid excise tax penalties. If a REIT cannot distribute 90% of its taxable income by December 31 of the tax year, it has the following options to consider:
- Section 857(b)(9): Dividends declared in October, November or December and paid by January 31 of the following year are treated as if paid on December 31 of the prior year. This allows flexibility in timing distributions for compliance.
- Section 858(a) “throwback” rule: REITs can elect to treat distributions made in the following year, before filing the prior year’s tax return, as paid on December 31 of the prior year. However, you must keep in mind these are taxed to shareholders in the year paid and are not included for excise tax calculations. For 2024, if you do have a Section 858(a) dividend, you could have a different amount for dividend paid deduction and a different distribution amount for 1099 reporting.
Meeting the 90% distribution requirement doesn’t always mean distributing cash. The following options may also be available:
- Elective Stock Dividends: Listed REITs can pay dividends as a mix of cash and stock. If at least 20% of the dividend is paid in cash, the entire amount counts as a cash distribution for compliance purposes. Many REITs use an 80/20 stock-cash mix to conserve cash.
- Consent Dividends: Shareholders can agree to include a noncash consent distribution in their taxable income. This increases their basis in REIT stock and allows the REIT to deduct the distribution. Please note this is not practical strategy for public REITs and is mostly used by private REITs.
Review your distribution plan now to ensure compliance and minimize tax exposure.
