Real estate investing is one of the best strategies to achieve wealth and financial independence in Bangladesh. The fact that owning a property is similar to operating a small business makes it simpler to be able to write off numerous expenses. When you borrow money to buy a house, you are eligible for a number of tax incentives and deductions that can help you manage your cash flow in addition to lowering your tax obligation. However, tax law can be somewhat difficult.
Tax Benefits of REITs
Through the end of 2025, pass-through income is eligible for a 20 percent deduction under current federal tax laws. Individual owners of REITs are permitted to deduct 20% of their taxable REIT dividend income (but not for dividends that qualify for the capital gains rates). There is no maximum deduction allowed, there are no wage limitations, and itemized deductions are not necessary to qualify for this benefit. For a person in the top tax bracket, this provision (qualified business income) effectively reduces the federal tax rate on ordinary REIT dividends from 37 percent to 29.6 percent.
An Explanation of Individual Taxation
Shareholders in REITs may be subject to complex income tax obligations. Each distribution, or dividend payout, received by investors in taxable accounts is made up of funds that the REIT has collected from a variety of sources and classifications, each with its own set of tax implications.
The company’s operating profit frequently makes up the majority of REIT dividend payments. This profit is passed through to the shareholder as regular income and is taxed as nonqualified dividends at the investor’s marginal income tax rate because the shareholder owns a stake of the REIT company.
However, occasionally a portion of operational profit that was previously exempt from taxes because of depreciation of real estate assets would be included in REIT dividends. This component of the dividend, also known as the ROC, is regarded as a nontaxable return of capital. It lowers the dividend’s tax burden while simultaneously lowering the investor’s cost basis per share. Although a lower cost basis will result in more taxes being owed when the REIT shares are eventually sold, it will not affect the tax liability of current income from REIT dividends. This clause may offer chances for income planning, such as the capacity to spread income over several years, for people with greater taxable incomes in the near future.
Taxation of REITs: A Short Lesson
Real estate investment trusts (REITs) have grown in popularity since its introduction in 1960 as a choice for income investors.
High dividend yields and the possibility for capital growth are common features of REITs, which also make it simple to obtain exposure to the real estate markets without the hassles associated with holding real estate directly.
However, it’s crucial to comprehend REIT taxes. Let’s quickly go over how REITs operate before discussing how they are taxed.
Example of Unitholder Tax Calculation
A REIT is purchased by an investor for $20 per unit. From operations, the REIT generates $2 per unit and pays out 90% (or $1.80) to unitholders. The dividend on this is made up of $1.20 in earnings. The remaining $0.60 is a nontaxable return of capital and is derived from depreciation and other costs.
The $1.20 would be subject to ordinary income taxes for the investor in the year of receipt. The investor’s cost basis is lowered to $19.40 per share by a $0.60 reduction. As previously said, when the units are sold, this basis reduction will be taxed as either a long- or short-term gain or loss.
The Tax Reform Benefits REITs
The 2017 Tax Cuts and Jobs Act has created a new 20 percent deduction on pass-through income that is now accessible through the end of 2025, which is a big benefit for REIT owners.
Individual REIT owners can now deduct 20% of their taxable REIT dividend income from their taxable REIT income, but only if the dividend payment is not subject to capital gains rates. There is no cap on the deduction or wage restriction, and investors are not required to itemize deductions in order to profit from this provision.
The federal tax rate on traditional REIT dividends (including mortgage REITs) for a taxpayer in the highest band was effectively decreased by the tax bill from 37 percent to 29.6 percent. Although this sum is a step in the right direction, it still exceeds the 20 percent cap on the tax rate that can be applied to eligible dividends paid by corporations.
Final Words on REIT Taxes
The majority of REIT dividend payouts are often taxed at ordinary income rates rather than the reduced long-term capital gains rate that is applicable to qualified dividends due to the non-qualified character of most REIT dividends.
Because of this, tax-advantaged vehicles like IRAs and 401(k)s are frequently better equipped to fully benefit from REIT income.