Real Estate Investment Trust (REIT)

A real estate investment trust (REIT) is a company that owns, operates, or finances income-producing real estate, created by Congress in 1960 to give ordinary investors property exposure without buying property. To keep the tax status, a REIT must invest at least 75% of assets in real estate and derive 75% of income from rent or mortgage interest. It must also distribute at least 90% of taxable income as dividends. The distribution requirement is why REITs pay high yields, and it is also why they retain little earnings to compound internally.

The tax treatment is the catch. Because the REIT deducts its dividends before corporate tax, the IRS taxes most REIT dividends as ordinary income, nonqualified by statute, at rates up to 37%. Equity REITs own buildings across data centers, towers, warehouses, apartments, and self-storage; mortgage REITs lend against property and run with far more leverage. Roughly 200 REITs trade on US exchanges, and real estate has been its own S&P 500 sector since 2016.

The economics run through the distribution requirement. Rent comes in, operating costs come out, and at least 90% of taxable income must leave as dividends to shareholders, which is why a $10,000 REIT position at a 4% yield pays $400 a year. The requirement starves the REIT of retained earnings, so growth is funded by issuing new shares or debt rather than compounding internally. That is the structural difference between a REIT and an ordinary company.

The two families behave differently. Equity REITs own the buildings and earn rent, with moderate leverage and steady income; mortgage REITs own the loans, run with heavy leverage, and pay higher yields that collapse in rate shocks. Sectors carry their own cycles: data centers and towers grew through the 2020s while office property struggled with vacancies. A diversified REIT fund spreads the exposure across sectors automatically.

The tax flows through Form 1099-DIV, with most of the distribution in the ordinary income box rather than the qualified box. In a taxable account that is the expensive tier; in a Roth IRA or 401(k), the same dollars compound with no annual tax. Placement is the lever an investor controls.

REITs are the answer to a real question: how do I own property without a down payment, a mortgage, tenants, or a Saturday spent on a flooded basement. The trade is the tax bill. A 4% yield in a taxable account at the 24% bracket nets 3.04%; the same yield inside a Roth IRA nets 4%. Over decades, placement decides the return.

I watched a colleague named Brent (yes, that Brent) buy a REIT fund in his taxable brokerage for the yield, then act surprised when the 1099-DIV arrived with everything in the ordinary box. The dividends were fine. The tax tier was not, and the fix had existed in his Roth the whole time.

The highest-leverage thing most Americans can do is hold REITs in tax-advantaged accounts, size them as a diversifier rather than a core holding, and run the placement math before buying. Check the after-tax yield with the REIT tax equivalent calculator or the asset allocation calculator.