Can an LLC Really Be a REIT for Taxes? – Yes, But Avoid This Mistake + FAQs

Lana Dolyna, EA, CTC

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U.S. real estate investment trusts (REITs) collectively paid out over $90 billion in dividends in a single year, showcasing how powerful this structure can be for investors. So, can your LLC take advantage of the REIT framework for tax purposes?

Quick Answer: Yes – an LLC can elect to be treated as a REIT for tax purposes, but only if it meets strict IRS requirements.

In practice, that means the LLC must opt to be taxed as a corporation and satisfy all the REIT rules (like having 100+ owners, primarily real estate income, and paying out most of its earnings as dividends).

It’s absolutely possible, but it requires careful planning and compliance with both federal tax law and any state-specific rules.

LLC vs. REIT – Clearing the Confusion

Before jumping into how an LLC can qualify as a REIT, it’s crucial to understand what each term really means. An LLC and a REIT are not apples-to-apples – one is a type of legal business entity, the other is a special tax status. Let’s unpack these basics first, so the path forward becomes crystal clear.

LLC 101: The Flexible Business “Chameleon”

An LLC (Limited Liability Company) is a business structure created under state law that’s prized for its flexibility. Think of an LLC as a legal container for a business or investment:

Limited Liability: Just like a corporation, an LLC shields its owners (called members) from personal liability for business debts. If something goes wrong with the property or business in the LLC, generally the members’ personal assets are protected.
Flexible Ownership: An LLC can have one owner (single-member) or many. Owners can be individuals, other companies, or even foreign entities. This makes it popular for holding real estate, where one person or a small group might own several properties via an LLC.
Tax “Chameleon”: Here’s where an LLC is unique – for tax purposes, it can shape-shift. By default, a single-member LLC is disregarded (treated as part of its owner), and a multi-member LLC is taxed as a partnership. But an LLC can elect to be taxed as a corporation if that suits its goals. It can even go further and elect S-corporation status if eligible. This check-the-box flexibility is key to our REIT discussion (as we’ll see, an LLC needs to be taxed as a corporation to pursue REIT status).

Bottom line: An LLC is a legal entity type known for liability protection and tax flexibility. However, “LLC” itself is not a tax category – it can be whatever tax flavor you choose (within IRS rules). This flexibility is why an LLC could become a REIT for tax purposes – but it has to play by the corporate tax rules to do so.

REIT 101: The Real Estate Income Machine

A REIT (Real Estate Investment Trust), on the other hand, is not a legal entity type but a special tax designation under federal law (specifically, under the IRS Code). Congress created REITs to let everyday investors pool money to invest in large-scale, income-producing real estate, without the double taxation that normally comes with corporations. Key features of a REIT include:

Tax-Favored Status: A REIT is generally a corporation (or trust/association) that doesn’t pay federal corporate income tax on its real estate profits. How? It qualifies for a deduction by paying out most of its income as dividends to shareholders. In essence, a REIT acts like a pass-through: profits “pass through” to investors and are taxed only at the investor level. This avoids the dreaded “double taxation” (corporation pays tax, then shareholders pay tax on dividends) that regular C-corporations face.
Real Estate Focus: By definition, a REIT must be in the business of owning/financing real estate. There are different types of REITs – equity REITs (owning properties like apartments, offices, malls), mortgage REITs (holding real estate loans), and hybrids – but all revolve around real estate assets and income. At least 75% of a REIT’s assets must be real estate related, and similarly most of its income (roughly 75% or more) must come from real estate sources (like rent, mortgage interest, or property sales).
High Dividend Requirement: REITs are required to distribute at least 90% of their taxable income to shareholders as dividends every year. (Most REITs distribute 100% to completely avoid any corporate tax). This means investors regularly get cash returns, and it ensures the REIT doesn’t hoard profits – which is part of why the tax code grants them pass-through treatment.
Broad Ownership: To prevent a REIT from just being a tax shelter for one person or a small group, the rules require a broad investor base. A REIT must have at least 100 shareholders (owners) by its second year of existence. And it cannot be too “closely held” – no five or fewer individuals can own more than 50% of its shares (this is known as the 5/50 rule). In other words, REITs have to be fairly widely held entities.
Strict Compliance: REITs must comply with a host of ongoing tests and regulations – from quarterly asset tests to annual income tests, as mentioned above. If they fail these tests, they can lose their REIT status and be taxed as a regular corporation (ouch!).

Bottom line: A REIT is essentially a tax classification for a company that mainly owns real estate and elects to follow a specific set of rules. In exchange for following these rules, a REIT pays little to no corporate tax – passing most of its earnings to investors who then handle the tax. Importantly, an entity has to choose to be taxed as a REIT (by meeting the criteria and filing as such); it’s not automatic and it’s completely optional. Many REITs are big public companies (think of REITs that trade on the stock exchange owning hundreds of shopping centers or apartment complexes), but REITs can also be private. Nothing in the rules says a REIT must be public – only that it meets the ownership spread requirements. This is where LLCs come into play for private real estate owners.

Now that we’ve set the stage – LLC as a flexible legal entity and REIT as a coveted tax status – we can address how these two concepts intersect.

Federal Tax Law Unlocked: How Your LLC Could Achieve REIT Status

Let’s get to the heart of the matter: How can an LLC qualify as a REIT under federal tax law? The IRS rules provide a pathway – but it requires intentional steps and compliance. Here’s the roadmap at the federal level.

Step 1: Elect Corporate Tax Status for the LLC (Check-the-Box Magic)

The very first hurdle: a REIT must be taxable as a corporation. The IRS rules for REITs say the entity must be a “corporation, trust, or association” for tax purposes. By default, a plain LLC doesn’t fit that bill – it’s taxed as a pass-through (not as a corporation). Fortunately, the IRS gives us a simple solution: “Check the box”.

Check-the-Box Election: An LLC can file a form (IRS Form 8832) to elect to be taxed as a C-corporation. This is literally like flipping a switch in how the IRS views your LLC – from that point on, the LLC is treated as if it were a corporation for federal tax purposes (and thus eligible to be a REIT if it meets the other requirements). This election doesn’t change the LLC’s legal nature at the state level – you still have an LLC legally – but for tax it’s now in the corporate realm.
Timing: Typically, you’d make this election effective at the start of a tax year in which you want to be a REIT. Many times, an LLC planning to become a REIT will elect corporate status effective January 1 of a year, and then also meet all REIT tests during that year so it can file as a REIT for that year.
Alternative – Formation as a Corporation/Trust: Instead of electing, an LLC could also convert to a corporation or form a trust, but using the check-the-box election often is simpler and avoids disrupting legal agreements. It basically lets you keep the LLC form (operating agreement, state filings, etc.) but just change the tax lens.
Note: Once taxed as a corporation, the LLC will generally be treated like a C-Corp. (Being an S-Corp is not compatible with REIT status – REITs have their own special tax regime and an entity can’t be both an S-Corp and a REIT. So C-Corp taxation is the way to go.)

In short, your LLC must first transform into a tax-paying corporation in the eyes of the IRS. Only then can it take the next step of making a REIT election. If you skip this, an LLC that remains a partnership or disregarded entity cannot be a REIT – it’s simply ineligible because it’s not a corporation for tax purposes. This is the foundational step that unlocks the possibility of REIT status.

Step 2: Meet the REIT Qualification Tests (IRS Rulebook for REITs)

Once your LLC is set to be taxed as a corporation, it must qualify as a REIT by meeting a laundry list of IRS requirements. These requirements cover the entity’s structure, its income sources, assets, distribution of profits, and ownership. Here are the key REIT tests your LLC-turned-corp needs to pass:

Entity Structure & Governance: The entity must be managed by a board of directors or trustees. Practically, if you keep the LLC form, you’ll need to have something analogous to a board (maybe you as the managing member and others as a board of advisors, or formally appoint a board in the operating agreement). Also, the ownership must be represented by transferable shares or certificates. In a corporate context, that’s stock shares; in an LLC, that could mean membership units that are transferable. Ensuring your LLC’s membership interests are freely transferable (and not locked down by agreements) is part of this requirement.
Asset Tests: At least 75% of the value of the entity’s assets must be real estate assets (such as actual real property, leasehold interests, or mortgages on real property), cash, and government securities. This is measured at the end of each quarter. In other words, your LLC can’t have a bunch of non-real estate businesses or investments on the side – it has to be predominantly a real estate holding entity. Additionally, there are limits on holding other corporate stock: generally, you can’t have more than 5% of assets in any one non-real estate company, and you can’t own more than 10% of the voting securities of a single corporate entity (with some exceptions, like Taxable REIT Subsidiaries – more on these later).
Income Tests: Similarly, at least 75% of the REIT’s gross income must come from real estate sources. This includes rents from real property, interest on mortgages secured by real property, gains from selling real estate (held long-term), and a few other real estate related incomes. Additionally, 95% of gross income must come from the above real estate sources plus other passive income like interest or dividends. These tests ensure that almost all of the REIT’s income is passive and real estate-related. If your LLC has been doing some active business (say property development and quick flips or running a construction arm), you might need to separate those out – a REIT can’t have too much non-qualifying income without jeopardizing its status.
Distribution (Payout) Test: The REIT (your LLC) must distribute to its shareholders at least 90% of its taxable income each year as dividends. This is the famous rule that forces REITs to pay out most of their earnings. Practically, to be safe, most aim for 100% distribution because any undistributed portion is taxed at the regular corporate rate. If your LLC used to retain cash for renovations or new acquisitions, as a REIT you’d be committing to pay out most earnings and perhaps raise new capital or borrow for growth instead of using retained earnings.
Ownership Tests:
- 100 Shareholder Minimum: By the start of its second taxable year as a REIT, the entity must have at least 100 distinct shareholders (members). For an LLC, this means you need 100 owners of membership units. Practically, this is a huge shift for many LLCs – if you currently have, say, 3 partners owning an LLC, you’d need to admit many more owners. Often, private REITs achieve this by bringing in a large pool of minor investors or structuring it so that interests are widely held (some even give tiny ownership stakes to friends, family, or outside investors to get over 100).
- 5/50 Rule (Concentration Test): At all times after the first year, no five or fewer individuals can own more than 50% of the REIT’s shares. This prevents a REIT from being too closely held by a small group. There are complex attribution rules here (family members’ ownership may be aggregated, etc.). For an LLC converting to a REIT, this means if originally you and a partner owned, say, 90%, you’ll have to seriously dilute that ownership among a larger pool. Many REITs write into their charter/operating agreement that no one can own above a certain percentage (like 9.8%) to ensure this test isn’t violated.
One Class of Ownership: Generally, a REIT needs to have one class of equity outstanding. You usually can’t have multiple classes of common equity with different preferences (though preferred stock is allowed under certain conditions). For an LLC, this translates to not having special membership classes that upset equal distribution rights. Many REITs (especially public) do issue preferred stock; that’s permissible. The main point is to avoid complex capital structures for the common equity that could violate the spirit of equal ownership interests.
Miscellaneous Requirements: There are a few other technical requirements (for example, you cannot be a financial institution or insurance company, and generally REIT shares must be transferable, as noted earlier). Also, a REIT must file an income tax return using Form 1120-REIT each year and should adopt a calendar year as its tax year in most cases (there are exceptions, but typical REITs use calendar year).

That’s a lot to digest! Let’s summarize the most critical REIT qualification criteria and what they mean for an LLC in a quick reference table:

REIT Requirement	What It Means for an LLC
Taxable as a Corporation	Must elect corporate tax status (an LLC must file Form 8832 to be treated as a C-corp for tax).
Managed by Directors/Trustees	LLC needs a governance structure like a board (not just member-managed in the traditional sense).
Shares Must Be Transferable	LLC membership interests should be freely transferable (no overly restrictive transfer clauses).
100+ Owners by Year 2	The LLC must bring in a large number of investors (can’t remain a closely held few-member company).
5/50 Ownership Limit	No small group can own the majority: original owners must be willing to spread ownership and possibly impose caps on ownership percentages.
75%+ Assets in Real Estate	The LLC’s assets should mostly be real property or mortgages. Diversify non-real estate investments or pare them down.
75%+ Income from Real Estate	The LLC’s revenue must predominantly come from rents, interest on real estate loans, property sales (not from unrelated businesses).
95%+ Income from Passive Sources	Almost all income should be passive (real estate or other investment income). Active business income should be minimized or moved to a taxable subsidiary.
90%+ Income Paid as Dividends	Plan to distribute the vast bulk of earnings to owners each year; limited reinvestment of profits.
Single Class of Common Equity	Simplify the equity structure (one type of membership unit for common owners; preferred equity allowed within limits).

As you can see, qualifying as a REIT is no small feat. For an LLC, some of these requirements might require major changes in how you operate and who your owners are. However, for entities with large real estate portfolios seeking capital and tax efficiency, these changes can be worthwhile.

Step 3: Elect REIT Status and Comply Annually

After ensuring you can meet all the tests above, the final step is actually electing REIT status and maintaining it. How do you do that?

Filing as a REIT: There isn’t a special form that you send in to “apply” and get approved like some club. Instead, you simply file your tax return as a REIT (Form 1120-REIT) for the year you want to start REIT status, and attach a statement that you’re electing to be treated as a REIT under Section 856(c)(1) of the Internal Revenue Code. If it’s your first year and you’ve met all the conditions throughout that year, the IRS will process the return and accept the election, granting you REIT status for that year.
Initial Grace Period: The first year, you don’t need 100 owners until the very end. Actually, the rule is by your second taxable year you must meet the 100 shareholders test. So an LLC could elect REIT in year 1 with fewer owners (even a single owner at the very start), as long as by the second year it complies. However, practically, you should have a plan in motion to get those owners on board because you must meet it for at least 335 days of year 2.
Annual Compliance: Every year, the REIT has to continue meeting all the income, asset, and distribution requirements. This means meticulous record-keeping:
- Quarterly checking of asset composition.
- Tracking income sources to ensure you’re above the 75% and 95% thresholds.
- Making dividend decisions and payouts before deadlines (a REIT can actually pay its required dividends by end of the next year’s Jan if needed, with a special designation, but generally by year-end).
- Monitoring ownership – many private REITs will send out an annual shareholder survey or affidavit to ensure no prohibited concentrations (asking big owners to confirm their ownership percentages and whether they are individuals, etc., to apply the 5/50 rule).
Failure and Penalties: If you slip up, the consequences vary:
- Fail the 100 shareholders or 5/50 rule? You could lose REIT status immediately (and be taxed as a C-corp, ouch). Sometimes there are relief provisions if it was inadvertent and you try to fix it, but those are not guarantees.
- Fail an income or asset test by a small margin? The tax code provides some relief: if it was a good-faith mistake and you take corrective action (like dispose of a bad asset), you might pay a penalty tax but keep REIT status.
- Miss the distribution 90%? If you don’t distribute at least 90%, you technically don’t qualify as REIT that year. Usually, REITs carefully ensure they do. There is also a special 4% excise tax if a REIT fails to distribute a certain amount by year-end (85% of ordinary income plus other specifics).
- In short, once you’re a REIT, staying a REIT becomes a continuous responsibility.

At the federal level, the path is clear: your LLC can don the REIT “costume,” but it must first become a corporate taxpayer and then meticulously meet the REIT rules each year. This is the core of how an LLC becomes a REIT for tax purposes under U.S. federal law.

Next, we’ll explore something people often overlook: state-level nuances. Just because the IRS treats your LLC as a REIT doesn’t automatically mean every state will give you the same treatment or benefits. State taxation and laws add another layer to consider.

State-by-State Nuances: Will States Treat Your LLC REIT the Same Way?

Federal law might allow your LLC to be a REIT for tax purposes, but state laws can have their own twists. There are two aspects to consider: (1) state legal requirements for forming/operating such an entity, and (2) state tax treatment of REIT income and dividends. Let’s break down what to watch out for at the state level:

State Law: Forming an LLC vs. REIT Structures

No “REIT LLC” Entity Type: Remember, “REIT” is not a legal entity type; it’s a tax status. So you don’t go to a state and form a “REIT LLC” officially. You form an LLC (or corporation or trust) under that state’s laws. Each state has its own LLC Act and corporate laws. The good news is, there’s generally no state law prohibiting an LLC from qualifying as a REIT for tax – because that’s mostly tax code business. However, a few states have specialized statutes for REITs (for example, Maryland has a whole REIT law allowing formation of a “Maryland real estate investment trust” as a type of unincorporated trust entity). Many large REITs choose to incorporate or form trusts in Delaware or Maryland, due to their management-friendly laws and established legal precedents for REITs.
LLC Operating Agreement Adjustments: If you keep the LLC form, you may need to tweak your operating agreement to align with REIT requirements. For instance:
- Implement Ownership Limits: Many REIT charters say “no shareholder may own more than 9.8%” (to help comply with the 5/50 rule). Your LLC agreement might include a similar provision restricting any member from getting too large an interest, or enabling the LLC to force a sale of interests if needed to stay within limits.
- Allow Transfers: Typically, LLCs run by a small group might have right of first refusal on transfers or other hurdles. For REIT status, you need free transferability of shares (membership units). You might have to relax those transfer restrictions (except those necessary to avoid violating securities laws for a private company).
- Board Structure: Consider establishing a board of directors/managers if you haven’t already, to satisfy the “managed by directors or trustees” requirement in spirit. Many states allow an LLC to have a board or to vest management in managers instead of members.
State Securities Laws: If you’re bringing in 100+ investors, even if not publicly traded, you’re effectively conducting a private offering of shares in your LLC. You’ll need to comply with federal and state securities laws (usually via exemptions like Regulation D if in the U.S.). While beyond our tax focus, just remember – adding lots of investors triggers these legal considerations too.

State Taxation: REIT Income and Dividends at the State Level

Here’s a kicker: Not all states treat REITs as generously as the federal government does. While most states start their corporate tax calculations with federal taxable income (which for a REIT can be near zero after the dividends-paid deduction), some have decoupling or special rules. Key points:

Most States Follow Federal Lead: In many states, if your LLC qualifies as a REIT and therefore pays no federal corporate tax (because it distributed its income), the state’s corporate tax code will likely also show little or no taxable income for that entity. States that use federal taxable income as a starting point will see that the REIT’s taxable income is mostly zero (thanks to the dividends-paid deduction reducing taxable income) and thus the state corporate tax would also be zero. For example: If your LLC-REIT earned $1,000,000 and paid $900,000 in dividends, federally it might only be taxed on $100,000 (if it didn’t distribute that part). If that $100,000 was also paid via a special year-end spillover dividend or applied to next year, federal taxable income could be zero. States would likewise tax little or nothing in that scenario.
State-Level REIT Taxes or Fees: Some states impose alternative taxes. California, for instance, doesn’t have a separate corporate income tax for REITs (it follows federal taxable income) but it does have a minimum franchise tax ($800 per year for LLCs or corporations) and an LLC fee based on gross receipts that might still apply if you remain an LLC entity. So even as a REIT, your LLC might pay California’s minimum taxes or fees. Always check the specific state’s franchise or excise tax rules.
“Captive REIT” Legislation: A number of states got wise to companies abusing REIT structures as a tax dodge. Large corporations in the 1990s and 2000s would sometimes put their real estate into a wholly-owned REIT (so the parent company basically gets rent expense deductions, and the REIT subsidiary pays no tax and sends dividends to the parent, which might then try to exclude those dividends). To curb this, some states implemented “captive REIT” laws. These laws typically deny the state deduction for dividends paid if the REIT is not publicly held or if it’s mostly owned by a single corporation.
- For example, Massachusetts historically had a dividends-received deduction for corporations that would have let a parent corp avoid tax on dividends from a REIT sub – they changed laws to limit that.
- North Carolina and others require that a REIT be at least 100 shareholders (the federal rule) and not majority-owned by one entity, otherwise the REIT must add back the dividends-paid deduction for state tax (in essence, nullifying the REIT benefit at the state level for captive REITs).
- Louisiana at one point challenged a REIT that was owned by an out-of-state entity, due to difficulty taxing the non-local shareholders.
- The specifics vary by state, but the gist is: if your LLC-REIT is essentially a closely controlled entity (like a parent company and some token outside owners), some states may still tax its income or disallow certain deductions.
State Property and Transfer Taxes: Being a REIT doesn’t typically change property tax or transfer tax obligations. If your LLC owns real estate, it still pays property taxes to counties/municipalities as usual. Some states might have slightly different rules for certain REIT-owned property transfers (for instance, a few jurisdictions have tried to impose transfer taxes if property is moved in/out of a REIT entity), but those are case-specific. For the most part, REIT status is about income tax, not property tax.
Local Taxes: If you are in a city with local business taxes (like New York City has a separate tax regime, or some cities have gross receipts taxes), you should check those too. NYC generally taxes regular C-corps with a General Corporation Tax but exempts REITs that meet certain ownership distribution (to avoid the parent-subsidiary trick). Other localities might not have special rules.

In summary, at the state level your LLC’s life as a REIT could be smooth if the state aligns with federal rules, or it could present extra tax costs if the state has anti-abuse provisions. It’s wise to:

Consult a state tax expert in any state where your LLC will file returns.
Possibly choose a state of formation or operation that is REIT-friendly (many REITs love Maryland or Delaware for formation, and states like Texas or Florida with no corporate income tax can be advantageous for operations).
Pay attention to any requirements to report REIT status to the state. Some states might require attaching the federal REIT election statement or other info in the state return.

Now that we’ve navigated the law, both federal and state, let’s talk about the practical implications. Why would you want your LLC to be a REIT, and what are the pros and cons? Are there scenarios where it’s beneficial vs. not? We’ll tackle that next, along with some concrete examples.

Pros, Cons & Comparisons: Is REIT Status Right for Your LLC?

Converting an LLC into a REIT isn’t just a theoretical exercise – it should serve a real purpose and provide net benefits. There are significant advantages to REIT status, but also non-trivial drawbacks and limitations. Let’s weigh them, and compare an LLC staying as a normal pass-through vs. electing REIT status.

Why Bother? – Potential Advantages of LLC-as-REIT

No Double Taxation, Even at Scale: If your real estate LLC grew large, normally you might incorporate and face C-corp double taxation on earnings. REIT status avoids the corporate tax as long as you distribute earnings. So you get the limited liability and capital access of a corporation with the tax efficiency of a partnership. For high-profit real estate portfolios, this can save a lot on taxes. Essentially, the income is only taxed once (at the owner level).
Access to Capital and Liquidity: REITs, by their nature, encourage bringing in many investors. If you want to raise capital for big projects, converting to a REIT structure could make your LLC more attractive. Investors often like the REIT model because they know they’ll get dividends and that the entity won’t retain earnings. Also, down the road, you could even go public as a REIT or attract institutional investors (many big funds and even retirement accounts love investing in REITs). The REIT framework is familiar to big investors, whereas a small LLC partnership might not be.
Potentially Higher After-Tax Yields for Owners: Consider an alternative: a normal C-corp pays 21% federal tax on its income, then any dividend to shareholders is taxed again (often at 15% or 20%). A REIT pays 0% at entity level if it distributes, and investors pay tax on dividends (at ordinary income rates up to 37%, but currently individuals get a 20% deduction on REIT dividends under the 2017 Tax Cuts and Jobs Act, making the effective top rate about 29.6%). In many cases, that overall tax hit can be lower than the combined corp + dividend tax. For example, $100 of pre-tax income yields roughly $79 to shareholders in a C-corp (after 21% corporate tax and then 15% on the remaining dividend). In a REIT, $100 distributed could yield around $70 after the investor’s tax (if at the highest bracket after the 20% deduction). For a high-bracket individual, that’s somewhat comparable – but for tax-exempt investors (like IRAs, pension funds) or foreign investors (who might have favorable treaty rates or exemptions), REIT distributions can be far more attractive. Tax-exempt entities in particular love REITs because those dividends often come to them tax-free (and do not count as unrelated business taxable income, even if the REIT uses debt financing – a huge plus over partnerships).
Retention of LLC Flexibility: By using an LLC to elect REIT status, you might get the best of both worlds legally. You keep an LLC operating agreement (which can be more flexible and less formal than corporate bylaws/shareholder meetings) and you can allocate special rights in ways a corporation might not (though careful: you still need only one class of common equity for REIT tests). LLCs can be easier to dissolve or adjust than corporations. So, you have some operational flexibility while enjoying REIT tax treatment.
Estate Planning and Wealth Diversification: If you’re a high-net-worth individual holding lots of property in an LLC, converting to a REIT can be a step towards estate planning. You could distribute REIT shares to family, use them in trusts, etc., more readily than slicing up illiquid real estate interests. Also, REIT shares (even if private) might allow family members to own pieces and benefit from income without directly entangling in property management.
Special Perks for Foreign Investors: Without going too deep, REITs have some special rules in international tax. A foreign investor selling a share of a U.S. property-owning corporation typically triggers U.S. tax under FIRPTA (foreign investment in real property tax). But if the corporation is a REIT and it’s “domestically controlled” (mostly U.S.-owned), foreign investors can sell shares without FIRPTA applying. That’s technical, but it means if you ever bring in foreign partners, a REIT can be a cleaner vehicle for them.

The Trade-Offs – Disadvantages and Challenges

Complexity and Compliance Costs: Running a REIT means a lot of compliance. Annual tests, additional tax return schedules, likely higher accounting and legal fees to ensure you don’t slip up. You might need to hire REIT tax experts, especially if issues arise (for instance, to request relief from IRS if a test is accidentally failed). An LLC with a couple properties and a handful of owners can file a simple partnership return; that same LLC as a REIT files a complex 1120-REIT and deals with shareholder communications and regulatory nuances. The cost and hassle go up significantly.
Must Have Many Owners: For an existing small LLC, the biggest hurdle is diluting ownership to get 100+ owners. You may not want that many people involved in your business. If you’re not already a larger company or prepared to essentially become one, this requirement is a show-stopper. Some people mitigate this by giving tiny slivers to many friends or relatives (with their consent) – e.g., to hit 100 shareholders – but managing that cap table (ownership list) can be a pain. Also, remember the 5/50 rule: you might have to genuinely give up a chunk of control; you and your closest allies can’t collectively own more than 50%. For founders, that can feel like a loss of control (even if you still manage day-to-day, technically you have to empower broader ownership).
Mandatory Payouts Limit Growth: REITs can’t easily reinvest profits. If your strategy involves accumulating rental income in the LLC to buy more properties, REIT rules will thwart that – you’ll be forced to payout and then, if you want more capital, you have to issue more shares or borrow. This can lead to dilution of ownership or taking on more debt. Some companies prefer the flexibility to retain earnings for expansion – an LLC (as a partnership or S-corp) allows that; a REIT effectively does not.
Dividend Tax Rates for Investors: The dividends owners get from a REIT are generally taxed as ordinary income (though again, currently with a 20% deduction for individuals through 2025). They are not “qualified dividends” eligible for the lower 15%/20% rate like typical corporate dividends. So if your members are in lower tax brackets, this might not matter; but if they’re high-income individuals, they’ll be paying up to 37% (down to ~29.6% after the deduction). In contrast, if you kept the properties in an LLC taxed as a partnership, the income each member gets retains its character – for instance, long-term capital gains from property sales can flow out and be taxed at 15%/20% to individuals. A REIT can also pass through capital gains (if it sells property and distributes the gain, that can be treated as capital gain dividend to shareholders – so that’s similar). However, normal rental income is ordinary for both REIT and partnership; but partnership income might be shielded by depreciation allocations in a more flexible way. REIT dividends might also be partly shielded by depreciation, effectively turning some into return of capital (tax-deferred), but that depends on each year’s numbers.
Loss of Tax Flexibility: When your LLC was a partnership, you had flexibility in allocating profits/losses, using losses to offset other income, etc. As a REIT (taxed as a C-corp), losses don’t flow out. If you have a loss, it stays at the corporate level (can be carried forward by the REIT, but the owners can’t use it on their personal taxes). Also, special allocations of income or deductions that partnerships can do (with agreements among members) are generally not allowed in a corporation – every share is equal. So some fine-grained tax planning is lost.
Ineligibility of S-Corp Benefits: Some LLCs elect S-Corp for certain self-employment tax advantages on active income. A REIT cannot be an S-Corp, so that’s off the table. If your use-case was holding operating business income, you’d lose the ability to minimize payroll taxes through an S-corp structure. (Though typically, REITs hold passive income, so this point is more for comparison.)
Scrutiny and Possible Changes: Tax laws can change. REITs have been around since 1960 and are well-established, but Congress occasionally tweaks requirements. Also, the IRS keeps an eye on abusive practices. If many private LLCs started pushing the envelope to become pseudo-REITs just for tax avoidance with minimal outside ownership, the IRS might scrutinize or the states might clamp down more. One must be prepared for regulatory changes or increased scrutiny.
Not Suitable for Flip or Development Businesses: If your LLC is more of a real estate developer (building and selling) or a flipper, REIT status won’t work well. REITs get penalized for selling properties too quickly (there’s a “prohibited transaction” tax 100% on gains from properties held less than 2 years and sold in dealer activity, with certain safe harbors). REITs are meant for long-term investment in real estate, not short-term profit from sales. So an LLC that’s in development might need to separate its development business (perhaps into a taxable REIT subsidiary or a separate entity) and only move stabilized assets into the REIT. This adds complexity.
Initial Tax Cost of Conversion: One more technical point – converting a partnership (LLC) to a corporation can have tax consequences. If your LLC has a lot of appreciated property and you incorporate it (via check-the-box to corporation), it might be treated as if the partnership contributed assets to a corporation in exchange for stock. Usually, that can be tax-free under IRS Section 351 if done right. But if the LLC has debt that exceeds the basis of assets for some members, there could be gain recognition. Also, down the road if you ever de-REIT or liquidate, built-in gains tax could hit. It’s a detailed area, but know that you should examine the tax impact of the initial conversion with a tax advisor to avoid surprises. In short, becoming a REIT is usually doable without immediate tax, but unwinding it could trigger taxes if not planned carefully.

LLC Pass-Through vs. LLC-REIT: A Quick Comparison

To crystallize the differences, here’s a concise comparison between keeping your LLC as a standard pass-through vs. turning it into a REIT (taxed as a corp but with REIT special treatment):

Factor	LLC as Pass-Through (Partnership/S-corp taxation)	LLC as REIT (C-corp taxation with REIT status)
Owners Required	1 (or any number, no minimum or max)	100+ (by second year, no 5 owners over 50%)
Type of Income Allowed	Any business or investment income	Primarily real estate rental/interest; very limited non-real-estate income
Tax at Entity Level	No (income passes to owners’ tax returns)	No federal tax if REIT rules met (pays dividends), otherwise 21% if fails criteria; some states might impose tax
Profit Distribution	Flexible – can retain earnings or distribute as desired	Mandatory – ~90% of income must be distributed each year to maintain status
Loss Utilization	Losses pass through to owners (they can use on personal return if rules allow)	Losses trapped at entity (can carry forward in REIT, but owners can’t directly use them)
Allocations	Flexible (profits, losses can be allocated in operating agreement as long as IRS rules for partnerships are respected)	Pro-rata only (each share/unit gets identical dividend; no special allocations of income)
Taxation of Distributions	Not applicable (distributions generally not taxed separately, since income already taxed to owners; except S-corp has some rules)	Dividends taxed to owners as dividend income (generally ordinary income; eligible for 20% QBI deduction currently; capital gain portion if REIT designates any)
Administrative Complexity	Low to moderate (annual partnership return, K-1s to members; fewer owners easier compliance)	High (annual corporate REIT return, multiple investor 1099-DIVs, compliance programs for tests, investor relations for 100+ owners)
Capital Raising	Private placements, harder to bring many investors without registering securities; not an established market structure	Easier to raise capital from REIT-focused investors; potential to attract institutional money or go public; more standardized investment vehicle (REIT shares)
Ideal for	Small group of active investors, flexibility in operations, those who want to reinvest cash flows, any type of income including active business	Large-scale passive real estate investment, especially if seeking external investors or going public, and aiming to maximize after-tax distributions for investors

As seen above, making your LLC into a REIT is almost like taking it from a small private business model to a quasi-public utility model (even if you remain private, you emulate a public company’s obligations in many ways).

Example Scenarios: How Real LLCs Transition to REITs

Sometimes it helps to see how this works in practice. Let’s look at two hypothetical scenarios illustrating when and how an LLC might become a REIT:

Example 1: “Family Real Estate LLC Goes Big”
The Smith family has a prosperous LLC, Smith Properties LLC, owning 20 large rental apartment complexes across several states. It started with just Mr. and Mrs. Smith and one of their children as members. The portfolio is now worth $200 million and generates $15 million a year in net rental income. They want to attract outside investors to buy more properties but also want to minimize taxes on the income. They consider converting to a REIT. Here’s what they do:

They consult with advisors and decide to elect corporate taxation for Smith Properties LLC effective Jan 1. Now it will be Smith Properties LLC, taxed as a C-corp.
They amend the operating agreement to mimic corporate bylaws: establishing a board of managers, allowing shares to be freely transferred, and inserting an ownership limit of 5% per investor to ensure no one can accidentally break the 5/50 rule.
Over the next year, they bring in investors by selling membership units. They admit 120 new investors, each taking small stakes (the family’s ownership goes from 100% down to about 40% collectively). They spread the ownership carefully so that by the end of the year, they have 130 owners and none of the five largest owners exceed 50% combined.
The LLC now meets the 100+ shareholders test and 5/50 test. Throughout the year, they also monitor income – virtually all is rent, which easily satisfies the 75% income test. They check assets – 90% of assets are apartment buildings, 10% is cash, so asset tests pass. They hire a REIT tax advisor to ensure even small details (like how rent from a tenant that also provides a service is treated) meet the rules.
At year-end, the LLC calculates its taxable income as a corporation. Say it’s $10 million after depreciation. They declare dividends of $9.5 million (95% of taxable income) to be safe above the 90% threshold, keeping a small cushion. All investors receive their share of this dividend.
The LLC files Form 1120-REIT for that year, claiming the dividends-paid deduction for the $9.5 million, resulting in minimal taxable income left (and thus little to no corporate tax due).
Result: Smith Properties LLC is now effectively operating as a REIT. The family gave up some ownership control but gained the ability to raise lots of capital from investors (they brought in, say, $50 million of new equity from those investors). The LLC pays no federal income tax on its real estate income, and the investors (including the Smiths) pay tax individually on the dividends they got. The Smiths also find that institutions are more willing to invest now – for instance, a pension fund is considering buying a stake, since pension funds are very comfortable with the REIT structure and love the steady dividends.

Example 2: “Small LLC, Not Ready Yet”
Jane Doe has a single rental property in an LLC (Doe Rentals LLC). It’s just her and a friend owning it, and it provides a nice side income. She’s heard about REITs and wonders if they can save her taxes. After research, she finds:

With only 2 owners and one property, converting to a REIT doesn’t make sense. She’d need 100 owners, which she doesn’t want, and the compliance burden would be enormous for such a small operation.
Instead, she keeps the LLC as a simple partnership for tax. They already enjoy pass-through taxation (no entity tax) in their current setup. A REIT wouldn’t actually save them tax because they already avoid double taxation by being a pass-through.
Moral: REIT status is more useful when you plan to scale up and take in a lot of capital. For small LLCs, the traditional LLC/partnership taxation already provides the benefit of single-taxation with far less complexity.

Real-World Note: Many private real estate firms only consider REIT status when they hit a certain size or want to go public or bring in big outside investors. For instance, some large private equity real estate funds create a private REIT to hold some assets because certain investors (like universities or endowments) can invest in the REIT without incurring unrelated business income tax (UBIT), whereas investing in a partnership could cause them tax headaches. In contrast, a family with a handful of properties won’t jump through REIT hoops without a compelling reason.

Key Terms Explained (Glossary)

To make sure we’re on the same page with jargon, here’s a quick glossary of key terms related to LLCs and REITs:

LLC (Limited Liability Company): A flexible business entity type created under state law that provides liability protection to owners. For tax, an LLC can choose how it’s classified (disregarded, partnership, or corporation).
REIT (Real Estate Investment Trust): A special tax status under federal law for a real estate company that meets certain requirements (primarily around having many owners, real estate-focused income, and paying out dividends). A REIT is taxed under the rules of Subchapter M of the Internal Revenue Code (similar to mutual funds).
Pass-Through Taxation: Tax concept where the entity itself is not taxed, but income “passes through” to the owners’ tax returns. Partnerships and S-Corps are pass-through; REITs are effectively pass-through because they deduct dividends, but technically a REIT is a corporation that can be subject to tax if it doesn’t meet requirements or doesn’t distribute income.
Double Taxation: In a regular C-Corporation, profits are taxed at the corporate level, and then when after-tax profits are distributed as dividends, those dividends are taxed again on the shareholder’s return. REITs avoid this by eliminating the corporate level tax (through the dividends-paid deduction).
Check-the-Box Election: An IRS procedure allowing certain business entities (like LLCs) to choose their tax classification. By filing Form 8832, an LLC can elect to be treated as a corporation (or vice versa, a corporation could elect to be treated as an LLC partnership if eligible and if converting, though usually LLC to corp is the relevant move for REITs).
Form 1120-REIT: The tax return form a REIT files annually with the IRS, similar to a corporate tax return but specifically for entities claiming REIT status.
100 Shareholder Test: REIT requirement that the entity have at least 100 distinct shareholders by its second taxable year as a REIT.
5/50 Test: REIT requirement that no five or fewer individuals can own more than 50% of the REIT’s stock (applied in the last half of each taxable year). This ensures a wide distribution of ownership.
Dividends-Paid Deduction: The mechanism that allows a REIT to avoid taxation. A REIT can deduct the dividends it pays to shareholders from its taxable income. If it pays out, say, 100% of its taxable income, it can deduct 100%, leaving $0 taxable income to be taxed at corporate rates.
Taxable REIT Subsidiary (TRS): A subsidiary of a REIT (often an LLC or corporation) that is fully taxable as a regular corporation. REITs use TRSs to do things they either aren’t allowed to do directly or that would generate non-qualifying income. For example, a REIT might own hotels but lease them to a TRS which actually operates the hotels (since operating a hotel is active business income, not passive rent, but rent paid from TRS to REIT is good income). A TRS pays corporate tax on its profits, but it can funnel allowable income (rents, interest, dividends) to the REIT. A REIT’s assets can include TRS stock up to a limit (no more than 20% of assets in TRS stock).
Captive REIT: An informal term for a REIT that is owned or controlled by a small number of entities, often used as an internal tax planning tool rather than a widely held investment vehicle. These triggered state anti-abuse rules.
Subchapter M: The part of the Internal Revenue Code that governs REIT taxation (and also RICs, regulated investment companies, like mutual funds). Subchapter M provides the rules that allow these entities a deduction for dividends and spells out all the qualification criteria.
Subchapter K: The part of the tax code dealing with partnership taxation (which is how LLCs with multiple members are taxed by default). Different from Subchapter M, particularly in allowing flow-through of losses and special allocations.
FIRPTA: The Foreign Investment in Real Property Tax Act – not directly about LLC vs REIT, but relevant if you have foreign investors. It basically taxes foreign persons on dispositions of U.S. real property interests. REIT shares are an exception if the REIT is domestically controlled or if the shares are publicly traded and the investor owns a small stake.

With these terms defined, you should be able to navigate discussions about LLCs and REITs with clarity.

Pitfalls and Misconceptions to Avoid

When exploring something as complex as turning an LLC into a REIT, there are plenty of ways to get tripped up. Here are some common pitfalls and misconceptions to watch out for:

Confusing Legal Entity with Tax Status: Don’t mix up your LLC’s legal form with its tax treatment. Just calling your LLC a “REIT” doesn’t magically change its tax status. You must make the IRS election and meet the tests. Conversely, you could have a corporation legally that is not a REIT because you never elected or don’t meet criteria. Always distinguish the wrapper (LLC, corporation, trust) from the tax label (REIT, partnership, etc.).
“My LLC has real estate, so it’s like a REIT, right?”: Wrong. Just owning real estate doesn’t make an entity a REIT. REIT status is an opt-in regime with specific requirements. Many real estate LLCs are simply taxed as partnerships – which is fine and often optimal for small-scale operations. You have to actively qualify and elect to be a REIT; otherwise, your default LLC taxation is not REIT.
Trying to REIT-ify a Single-Owner or Small-Group LLC: If you don’t plan to broaden ownership, don’t bother trying to be a REIT. You cannot circumvent the 100 shareholder rule. There’s no such thing as a single-member REIT – by the second year, that single member would cause disqualification. Some might think “maybe I can be a REIT for one year without 100 owners” – technically year 1 you can slip by on that test, but come year 2, if you don’t comply, you’re out. If you know you’ll never want lots of co-owners, REIT isn’t the path for you.
Missing the Subtle Deadlines: REIT timing can be tricky. For instance, you must have 100 owners for 335 days of a 12-month year (or 344 days of a leap year) in year 2. If you wait until December of the second year to add owners, that’s too late. You need them in place by early in year 2. Planning the timeline – including the initial check-the-box effective date and getting your investors in – is critical. Mark your calendar for all key deadlines (like distribution requirements, quarterly asset tests, etc.).
Ignoring the Distribution Requirement: It’s easy to focus so much on ownership and income tests that one might forget to actually pay out the earnings. If your LLC-REIT forgets to declare dividends sufficient to meet the 90% rule, you could accidentally lose your REIT status or at least face taxation on undistributed income. Always calculate the required dividend before year-end. A good practice is to slightly overshoot (pay 100% of taxable income minus a few dollars) to be safe.
Prohibited Transactions & Bad Income: If your LLC sells a property it has held for a short time (less than 2 years) or is in the business of flipping properties, those gains can be hit with a 100% penalty tax for REITs (meaning you gain nothing from the sale after tax!). There are safe harbor rules (like you can sell a limited number of properties per year, or do certain developments, etc.), but the takeaway is: Don’t assume you can continue any type of real estate activity within the REIT. Separate development or sales activities into a Taxable REIT Subsidiary or a separate LLC outside the REIT umbrella to avoid tainting your REIT with “bad” income.
Thinking REIT Dividends Are Tax-Free: Yes, the REIT doesn’t pay tax on them, but you do. Some novice investors are surprised when their REIT distributions come taxed as ordinary income (though again, a portion may be tax-advantaged due to depreciation as return of capital). Make sure you and any investors know that REIT dividends will be taxable to them each year (unless they’re in a tax-exempt account or entity). No deferral – if the REIT pays, you pay taxes on the dividend that year.
Mixing Up S-Corp Rules: If you previously thought of electing S-corp for your LLC (to save on self-employment taxes for example), note that S-corps and REITs don’t mix. You cannot be an S-corp and then elect REIT – they are separate tax statuses. Also, a REIT can have corporate shareholders, which S-corps can’t (so an S-corp owning a REIT is not possible either in general). Just remember to clearly decide which route you’re taking – for serious real estate ventures with lots of income, REIT (C-corp) might be better; for small owner-operated businesses, S-corp might be the path – they serve different needs.
Neglecting State Implications: As we discussed, check your state! Don’t assume “no federal tax = no state tax”. You might find later that your LLC-REIT owes some franchise tax or that your state required some addback making you lose the benefit. Plan for state taxes from the outset to avoid a nasty bill that undermines the expected tax savings.
Not Getting Professional Advice: This might sound self-serving, but a REIT conversion is complicated. The stakes (tax savings vs. potential tax disasters) are high. It’s highly recommended to involve a tax attorney or CPA who specializes in REITs when structuring your plan. They can guide on the best way to admit new investors (perhaps through a private placement), how to handle the check-the-box without triggering taxes, and ensuring ongoing compliance. Consider the cost of advice as insurance against messing up an intricate process.

Avoiding these pitfalls will set you on the right path and help ensure that if you do decide to turn your LLC into a REIT, you’ll actually reap the benefits without inadvertently falling into a trap.

Conclusion: Weighing the Decision for Your LLC

So, can an LLC be a REIT for tax purposes? Absolutely – it can, and many have done so successfully. By leveraging the LLC’s ability to elect corporate tax status and then satisfying the IRS’s REIT criteria, an LLC can morph into a tax-efficient REIT structure. This hybrid approach can combine the operational flexibility of an LLC with the tax advantages of a REIT, potentially yielding significant benefits in the right situation.

However, “can” doesn’t always mean “should.” The decision to pursue REIT status through an LLC is a big one and should be driven by scale, goals, and resources:

If you’re a small operation with a handful of owners and properties, a REIT election is likely unnecessary and overly burdensome.
If you have a large real estate enterprise (or aspirations to build one) with the need for outside capital or a plan to go public, REIT status could be a game-changer, eliminating entity-level tax and attracting investors who seek steady income.
Many factors – from federal tax efficiency to state tax outcomes, from compliance costs to investor relations – must be weighed. It’s not just a tax decision; it’s a business model decision.

Always perform a careful cost-benefit analysis. Talk to experts, run the numbers on tax savings versus administrative costs, consider the impact on your ownership and control, and envision the long-term strategy for your real estate venture.

In the end, the REIT model is a powerful tool in the real estate world – one that can unlock billions in capital (remember that stat: REITs own trillions in assets and pay out tens of billions in dividends). Your LLC can join those ranks under the right conditions. With the knowledge from this guide, you’re better equipped to determine if that path is right for you and how to navigate the journey if you choose to embark on it.

FAQ: Answering Your Questions on LLCs and REITs

Q: Can a single-member LLC qualify as a REIT?
A: No. A REIT must have at least 100 owners by its second year. A single-member LLC would need to bring in many additional owners to meet REIT requirements.

Q: Is it better to hold real estate in an LLC or a REIT?
A: For a small operation, a standard LLC (pass-through taxation) is simpler. A REIT makes sense for larger, income-producing portfolios where avoiding corporate tax and attracting investors outweighs compliance costs.

Q: Do REITs pay any taxes at the state level?
A: It depends on the state. Many states follow federal rules (so a REIT pays little/no state income tax), but some states tax REIT income or deny deductions if the REIT isn’t widely held (captive REIT laws).

Q: Can my LLC elect S-Corp status and later be a REIT?
A: No. REIT status is only available to entities taxed as C-Corporations. An LLC would have to terminate its S-Corp election (if it had one) and elect C-Corp taxation to pursue REIT status.

Q: Do I need to go public to have 100 shareholders for a REIT?
A: Not necessarily. You can stay private and have 100+ investors (friends, family, funds, etc.). Many REITs are private. Going public is an option to raise capital, but not a requirement for REIT status.

Q: What happens if a REIT fails to distribute 90% of its income?
A: It could lose REIT status for that year and be taxed as a regular corporation, meaning the income gets taxed at the corporate level. Most REITs avoid this by distributing 100% of taxable income.

Q: Are REIT dividends taxed at a lower rate like qualified dividends?
A: No, REIT dividends are generally taxed as ordinary income to investors (up to 37%). However, through 2025, individual investors can deduct 20% of REIT dividends, effectively lowering the top rate to ~29.6%.

Q: Can a foreign investor or an IRA invest in my LLC-REIT?
A: Yes. One appeal of REITs is that tax-exempt investors (like IRAs) and many foreign investors can invest without certain tax burdens (no UBIT for IRAs on REIT dividends; possible FIRPTA benefits for foreign investors).

Q: How long does it take to convert an LLC into a REIT?
A: It can generally be done by the start of your next tax year if planned properly. You’d make the tax election and restructure ownership before that year. Typically, allow a few months to set up everything (get new investors, change agreements) ahead of the effective date.

Q: Can a REIT own properties in multiple states through an LLC?
A: Yes. A REIT often uses subsidiary LLCs to hold individual properties in various states. The REIT can be a parent company that owns those LLCs (either disregarded or partnership subs or TRS as needed). The key is that the consolidated entity meets REIT tests.