Every new tax season dividend investors like us face the same daunting task of separating our dividend income into several categories and deciding where and how to report it. REIT dividends can be especially tricky. Are REIT dividends considered qualified dividends in the eyes of the IRS?
REIT dividends are not qualified dividends. According to the IRS, they are not qualified dividends even if they are shown in box 1b of Form 1099-DIV. Instead, REIT dividends are considered capital gains distributions. These are taxed at the same rate as qualified dividends if you meet holding requirement of one year or more.
What are qualified dividends?
Qualified dividends are dividends that meet certain requirements as stipulated by the IRS and are therefore subject to lower taxes. Qualified dividends are taxed at the long-term capital gains tax rate.
They were first introduced in the Bush tax cuts of 2003 in order to benefit investors who invest for the long term, i.e. retirement.
In table below you can see the difference in taxation between ordinary dividends – which are taxed as ordinary income – and qualified dividends – which are taxed as long-term capital gains.
|Long-Term Capital Gains
|$0 to $9,875
|$9,876 to $40,125
|$40,126 to $85,525
|$85,526 to $163,300
|$163,301 to $207,350
|$207,351 to $518,400
|$518,401 or more
|20% (over $441,550)
Especially, with lower income the long-term capital gains rate has a lot of advantages as you basically pay no tax up to around $40,000 in income.
As outlined by the IRS in their Publication 550 certain requirements have to be met in order for the dividends to qualify for the lower tax rate.
To qualify for the maximum rate, all of the following requirements must be met.
- The dividends must have been paid by a U.S. corporation or a qualified foreign corporation.
- The dividends are not of the type listed later under Dividends that are not qualified dividends.
- You meet the holding period.
The holding period means that you must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.
The ex-dividend date is the first date following the declaration of a dividend on which the buyer of a stock is not entitled to receive the next dividend payment.
When counting the number of days you held the stock, include the day you disposed of the stock, but not the day you acquired it.
Are REIT dividends qualified?
Let’s turn our attention to the problem at hand: REIT dividends. Given the requirements above it should be quite simple to figure out whether you can declare your REIT dividends as qualified and make use of the long-term capital gains tax rate.
However, there are some exceptions to the above rule. And REIT dividends are an exception.
If you scroll further down the wonderfully written Publication 550, you will the following sections:
Some dividends are not qualified dividends even if they meet all of the above requirements. Among those are capital gains distributions. This means that if REIT dividends were considered capital gains distributions they would not be qualified dividends.
If we then check the section titled “Capital Gains Distributions” it says that capital gains distributions (also called capital gain dividends) are paid to you or credited to your account by mutual (…) and real estate investment trusts (REITs).
In summary, REIT dividends are considered capital gains distributions, which are not qualified dividends.
Are REIT dividends taxed as ordinary income?
Generally, REIT dividends are not taxed as ordinary income. They are taxed as capital gain distributions that are subject to the long-term capital gains tax rate (see table above).
However, as with all tax-related answers, there are exceptions to this rule.
If you received capital gain distributions from a (…) real estate investment trust (REIT), the distributions of net realized short-term capital gains are not treated as capital gains. Instead, they are included on Form 1099-DIV as ordinary dividends. Report them on your tax return as ordinary dividends.
So, what does short-term mean in this context? Generally, if you hold the asset for more than one year before you dispose of it, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term.
Conclusively, REIT dividends are taxed as ordinary income if you have held shares of the REIT for less than one year. Otherwise the are taxed as capital gains.
Are REIT preferred dividends qualified?
For preferred stock, there are even more exceptions! Preferred dividends from REITs are subject to even stricter requirements than regular dividends.
According to the IRS, the following exception is valid for preferred stock:
In the case of preferred stock, you must have held the stock more than 90 days during the 181-day period that begins 90 days before the ex-dividend date if the dividends are due to periods totaling more than 366 days. If the preferred dividends are due to periods totaling less than 367 days, the holding period in the preceding paragraph applies.
This essentially just extends the minimum holding requirement for REIT preferred dividends from 60 to 90 days.
Which REITs have qualified dividends?
There are no REITs that have qualified dividends. REIT dividends are always either taxed as ordinary income or as capital gain distributions.
If REITs are taxed as capital gain distributions they are, however, subject to the same tax rate as qualified dividends. The long-term capital gains tax rate.
REITs that you hold for more than one year are treated as capital gain distributions.
Conclusively, all dividends from REITs that you have held for more than one year are taxed the same as qualified dividends (see table above).
How are REIT dividends reported?
REIT dividends are reported on Form 1099-DIV.
Some mutual funds and REITs keep their long-term capital gains and pay tax on them. You must treat your share of these gains as distributions, even though you did not actually receive them. However, they are not included on Form 1099-DIV. Instead, they are reported to you in box 1a of Form 2439.
REIT dividends are a peculiar topic. To every rule there seem to be a tedious amount of exceptions to go through.
Luckily, if you break it down it actually is quite simple.
As we have seen, REIT dividends cannot be considered qualified dividends since the fall under the capital gain distributions exception as outlined in Chapter 1 of the IRS Publication 550.
They are taxed as ordinary income if you have held the REIT shares for less than a year. If you exceed this minimum holding period, your REIT dividends are considered capital gain distributions. As a result, they will be taxed at the long-term capital gains rate.
In any case, it makes sense to aim for all your investment income to be taxed at the long-term capital gains rate because it can save you a lot of money!
For this, all you need to do is hold your REITs for more than a year and you’re all set.