Home » News & Insights » Understanding REITs and Their Structures

Understanding REITs and Their Structures

by | Apr 11, 2022 | REITs

Next year marks the 60th anniversary of the law that established real estate investment trusts (REITs), allowing investors looking to pool their resources to reap the rewards of income-producing properties.

REITs are designed  to allow individual investors access to the commercial real estate market with low investment minimums. Attracted by their strong dividend income and long-term capital appreciation, REITs have become a go-to asset for large and small investors alike.

Because of their broad audience with lower investment minimums, REITs are able to build sizable ownership portfolios. According to data from the National Association of Real Estate Investment Trusts, REITs of all types own more than $3 trillion in gross assets in the U.S. alone, or more than 500,000 properties. Some 87 million U.S. investors have REIT-related investments, mostly through their retirement plans, according to NAREIT.

Despite their ubiquity, REITs aren’t always well understood by investors. They have complex tax and reporting requirements and differing public and private ownership models. Herewith is a rundown of a few of the components that make REITs unique.

What Is a REIT?

A company may qualify as a REIT, under federal law, if a majority of its assets and income are connected to investing in real estate, and if 90 percent if its taxable income is returned to shareholders through dividends.

REITs must have boards of directors, a minimum of 100 shareholders after its first year as REIT. And no more than 50 percent its shares can be held by five or fewer individuals during the last half of the tax year. At least 75 percent of the REIT’s total assets should be invested in real estate and cash. And three-quarters of the gross income should come from real estate sources.

In addition, at least 95 percent of the REIT’s gross income must be derived from real estate sources. And no more than 25 percent of its assets should consist of non-qualifying securities or stock in taxable REIT subsidiaries.

Types of REITs

REITs typically fall into one of three categories. Equity REITs are the most common type, and in general, own and operate income-producing real estate. Mortgage REITs are designed to provide capital to real estate owners and operators via loans or mortgage-backed securities. Hybrid REITs deploy the investment strategies of both equity and mortgage REITs.

REITs are also generally classified by their status as publicly traded, non-traded or privately owned. Many equity and mortgage REITs are traded in the public markets and are registered with the Securities and Exchange Commission. Non-traded (private) REITs are also registered with the SEC, but are not publicly traded. Private REITs are sold through an exemption from registration and the stock typically cannot be traded.

Most REITs also specialize in a single type of real estate – such as, retail REITs, office REITs, residential REITs, among others.  As the SEC notes, “what distinguishes REITs from other real estate companies is that a REIT must acquire and develop its real estate properties primarily to operate them as part of its own investment portfolio, as opposed to reselling those properties after they have been developed.”

Tax advantages

REITs provide a series of tax advantages that burnish their attractiveness to potential investors.

  • Pass-through deduction. The most recent tax reforms, signed into law in 2017, allow for REIT investors to deduct up to 20 percent combined qualified income which includes qualified REIT dividends from income tax. (Dividends are taxed at income tax rates.)
  • No corporate tax. REITs distribute income to shareholders in the form of dividends. Under federal law, REIT dividends are shielded from corporate taxes, and investors pay only income tax on the dividend proceeds.
  • Depreciation. REITs are also allowed to take advantage of favorable tax rules around depreciation. REITs can use depreciation to reduce their ordinary income and reclassify it as return of capital.

Expert Advice

Given their complexity and ever-changing tax and compliance issues, REITs require experienced legal counsel. At KVCF, we’ve been recognized as a national leader in REIT law, and we represent clients on a broad range of transactional and operational issues.

Our REIT expertise includes qualifications and IRS requirements, classifications and structures, property management, investor evaluation, compliance and regulatory issues.

Contact us to learn more about how we can help.