Tax Reform Is a Windfall for REIT Investors

The new tax law benefits REIT investors more than it does the real estate investment trusts themselves.

REAL ESTATE HAS traditionally held up well against market swings and rising inflation. Real estate investment trusts offer a compact, tax-advantaged alternative to direct ownership, and thanks to tax reform, those advantages are better than ever.

The 2017 Tax Cuts and Jobs Act introduces several new measures affecting REIT taxation. "The new tax bill is a boon for REIT investors, but they need to be careful not to let the tax tail wag the dog," says Blake Morris, certified financial planner at The Lloyd Group in Suwanee, Georgia. "Many investors have used tax changes to drive investment decisions, only to quickly feel the pain."

Tax reform may also have a broader impact on some REIT sectors that could also influence performance and returns. As you shape your REIT investing strategy, think about how tax reform comes into play.

Pass-through income gets a big tax break. One of the central features of the tax bill is a new 20 percent deduction on pass-through income. This deduction applies to businesses that operate as pass-through entities, REITs included. "REITs are mandated to distribute at least 90 percent of their income, and REITs do not pay taxes on this distributed income," says Austin Pickle, investment strategy analyst for Wells Fargo Investment Institute in Sarasota, Florida.

This means REITs generally don't owe any taxes, leaving more of their earnings to be passed on in the form of dividends to investors, who are taxed on that income. As a result, "the new tax law benefits REIT shareholders more than the REITs themselves," Pickle says.

That's because REIT dividends are taxed at the individual shareholder's rate, rather than the corporate rate, says Scott Crowe, chief investment strategist for CenterSquare Investment Management in Plymouth Meeting, Pennsylvania. The 20 percent pass-through deduction reduces the top tax rate on REIT dividends from 39.6 percent to 29.6 percent for a taxpayer in the highest tax bracket. And "shareholders in lower brackets would have even lower rates on the same dividends."