Should REITS Really Be in a Taxable Account? – Avoid This Mistake + FAQs

Most investors should avoid holding REITs in a taxable account because REIT dividends are heavily taxed as ordinary income.

REITs typically belong in tax-advantaged accounts (like IRAs) for maximum tax efficiency and growth.

Picture this: you excitedly pocket a 4% annual dividend yield from your favorite REIT (Real Estate Investment Trust), only to get a hefty tax bill in April. 😱

Surprise: Those juicy REIT dividends can be taxed at up to 37% (plus 3.8% Medicare surtax) by the IRS, far higher than the 15% rate on typical stock dividends. No wonder investors are asking whether holding REITs in a regular taxable brokerage account is a smart move.

In this comprehensive guide, we’ll answer “Should REITs be in a taxable account?” once and for all. Along the way, we’ll explore strategies to minimize taxes, real-world examples of what happens at tax time, and how REITs compare to stocks, bonds, and more. Let’s dive in!

What you’ll learn in this article:

• Why taxes hit REIT dividends so hard: Understand federal tax rules (and a 20% tax break you might be missing) that make REITs tricky in taxable accounts.

• Pitfalls to avoid: Common mistakes investors make with REITs in taxable accounts (and how to sidestep costly tax surprises 💸).

• Key concepts explained: Quick definitions of important terms like pass-through taxation, qualified vs. non-qualified dividends, Form 1099-DIV, Tax Cuts and Jobs Act, and more.

• Real-world tax scenarios: How different investors (from beginners to pros) fared holding residential and commercial REITs in taxable accounts – with numbers and outcomes.

• REITs vs other investments: A side-by-side comparison of REITs, stocks, bonds, and other assets in taxable accounts, plus a pros and cons breakdown to inform your strategy.

📢 Quick Answer: REITs Thrive Better in Tax-Advantaged Accounts

When it comes to holding REITs in a taxable account, the general consensus is clear: it’s usually not ideal. REITs spit out high-yield dividends (by law they must pay out 90% of their taxable income), and the IRS mostly taxes those payouts at your full ordinary income rate. This means if you’re in a high tax bracket, you could lose a third or more of each REIT dividend to federal taxes alone.

So, should you put REITs in a taxable account? For most investors, the answer is “not if you can help it.”

You’ll typically want to stash REITs inside a tax-advantaged account – like a Traditional IRA, Roth IRA, or 401(k) – where those dividends can grow and compound without getting chopped by Uncle Sam every year. In a Roth IRA, especially, REIT dividends become tax-free forever (yes, please!).

That said, it’s not a black-and-white rule. Some investors do hold REITs in taxable accounts and make it work. Why might someone do this? Perhaps:

• They’ve already maxed out their IRA/401(k) and still want more REIT exposure.

• They’re in a lower tax bracket (so the tax bite on REIT income isn’t as painful).

• They value immediate income from REIT dividends for living expenses, and don’t mind paying some tax for the cash flow.

• The REIT has special tax benefits (like large depreciation write-offs) that make part of its dividends tax-deferred as return of capital.

In such cases, holding a REIT in taxable can be reasonable – as long as you’re aware of the tax implications and plan accordingly.

To weigh the decision, let’s quickly look at the pros and cons of keeping REITs in a taxable account:

As you can see, the scales generally tip toward “keep REITs out of taxable” unless you have a compelling reason. If you have room in an IRA or 401(k), that’s usually the better home for REIT investments. The tax savings over the years can significantly boost your net returns.

Next, let’s examine some common mistakes people make with REITs in taxable accounts (so you can avoid them), and then break down the tax rules and scenarios in detail.

😱 Pitfalls and Tax Traps to Avoid with REITs in Taxable Accounts

Even seasoned investors have tripped up when handling REITs in a normal brokerage account. Here are some common pitfalls to watch out for:

• Assuming REIT Dividends Are “Qualified.” One big mistake is treating REIT dividends like regular stock dividends. Unlike typical blue-chip stock dividends (which usually qualify for a lower 15% tax rate), REIT dividends are mostly non-qualified. That means they’re taxed as ordinary income by default. If you didn’t realize this, you might be in for a nasty surprise at tax time when you owe far more than expected. Avoidance Tip: Always check your 1099-DIV – it will explicitly show how much of your REIT’s payout was ordinary vs. qualified. Plan for the higher tax on the ordinary portion.

• Not Saving for the Tax Bill. REITs often have high yields (4%, 5%, even 8%+ for some commercial or mortgage REITs). It feels great to receive those quarterly dividends – until you remember the IRS wants its cut. A common blunder is spending or reinvesting 100% of those dividends and forgetting to set aside money for taxes. Come April, you’re scrambling to pay the tax on income you’ve already spent. 😬

• Avoidance Tip: If you hold REITs in taxable, consider automatically setting aside, say, 20-30% of each dividend for taxes (more if you’re high bracket, less if low). Alternatively, adjust your quarterly estimated taxes to cover the dividend income.

• Ignoring Return of Capital Adjustments. Many equity REITs (especially those owning real estate with lots of depreciation) will classify a portion of their dividend as return of capital (ROC). This part isn’t taxed in the year received – which is good – but it lowers your cost basis in the investment. A frequent mistake is forgetting to track this basis reduction. Years later, when you sell the REIT shares, you might underreport your cost basis, leading to overpaying tax on the sale, or worse, be caught off guard by a larger capital gain because all those untaxed ROC portions accumulated.

• Avoidance Tip: Keep a record of any non-taxable (ROC) distributions. Your broker’s 1099-B may or may not adjust for it. Ensure your cost basis for the REIT stock is adjusted downward by the total ROC received over time. This way, you correctly calculate gains when selling.

• Leaving REITs in Taxable When IRA Space Is Empty. Asset location matters. We’ve seen investors park REITs in a taxable account while holding cash or tax-free bonds in an IRA – an inefficient setup. Why pay tax on REIT dividends unnecessarily? The mistake here is not utilizing tax-sheltered accounts for the most tax-inefficient assets.

• Avoidance Tip: Fill up your IRA/401(k) with REITs and other high-tax assets (like taxable bonds) first. Only put REITs in taxable if you’ve filled your tax-advantaged space or have other strategic reasons.

• Overlooking the 20% Qualified Business Income Deduction. The Tax Cuts and Jobs Act introduced a 20% tax deduction for “qualified REIT dividends” (available through 2025). Some investors miss this when doing taxes (especially if DIY). The deduction effectively reduces the taxable portion of your REIT dividends.

• Mistake to avoid: not claiming this deduction (or using tax software that doesn’t automatically apply it). Also, remember this deduction doesn’t apply if your REIT is in an IRA (since there’s no taxable dividend to deduct – a nuance that actually makes taxable holding slightly more attractive than it used to be).

• Avoidance Tip: When holding REITs in taxable, ensure Form 8995 or 8995-A (QBI deduction form) is included in your tax return to capture that 20% REIT dividend deduction.

• State Tax Blind Spots. If you live in a state with high income taxes, don’t forget that REIT dividends will usually count as taxable income there too. A mistake is focusing only on federal tax and ignoring that, say, California’s 13.3% tax or New York’s ~10% tax may hit those REIT payouts as well. In states without a special break for dividends, your state tax can significantly compound the tax drag.

• Avoidance Tip: Factor in your state’s tax bite. In a high-tax state, it’s even more beneficial to shield REITs in an IRA or Roth if possible. Conversely, if you live in a state with no income tax (hello, Florida, Texas, etc.), the state-level argument against taxable REITs disappears – one less concern.

By steering clear of these pitfalls, you can at least minimize headaches and extra costs. Next, let’s clarify some jargon and concepts behind these issues, so you fully understand the tax landscape around REIT investments.

📚 Key Terms and Concepts (REITs & Taxation Glossary)

Before we dive deeper, let’s demystify some key terms. Understanding these will help you make sense of the tax implications and strategies:

• REIT (Real Estate Investment Trust): A special type of company that owns income-producing real estate (like apartments, offices, shopping centers, or even cell towers and warehouses). REITs are required by law to distribute at least 90% of their taxable income to shareholders as dividends. In exchange, they pay no corporate income tax (they’re a pass-through entity). There are residential REITs (focused on housing properties) and commercial REITs (offices, retail, industrial, etc.), but for taxes, all REIT dividends are treated similarly.

• Taxable Account: A regular brokerage account (or any investment account that’s not tax-sheltered). Income earned in these accounts (dividends, interest, capital gains from sales) is generally subject to taxes in the year it’s realized. Example: a standard online brokerage account or joint investment account is taxable.

• Tax-Advantaged Account: Accounts that give you a tax benefit, such as tax deferral or exemption. Examples: Traditional IRA, 401(k), or 403(b) (tax-deferred, meaning you don’t pay taxes on investment income as it accrues, only when you withdraw later), and Roth IRA or Roth 401(k) (tax-exempt on growth: you pay in after-tax dollars, but all future growth and withdrawals are tax-free). Holding investments like REITs here shields their dividends from current taxes.

• Ordinary Income Tax Rate: The tax rate you pay on ordinary income – like salary, interest, or non-qualified dividends. The U.S. has a progressive tax system with brackets (10%, 12%, 22%, 24%, 32%, 35%, 37% for federal as of 2025). REIT dividends typically fall in this category (taxed at whatever your marginal rate is).

• Qualified Dividend: A dividend from a U.S. corporation (or qualified foreign company) that meets certain IRS criteria to be taxed at the long-term capital gains rate (0%, 15%, or 20% depending on your bracket, much lower than ordinary rates for most folks). Most regular stock dividends (e.g., from Apple or Coca-Cola) are “qualified.” Important: REIT dividends are not qualified in this sense (since REITs don’t pay corporate tax). So they don’t get that lower rate – unless the REIT dividend is specifically designated as a capital gains distribution or comes from a taxable subsidiary (rare cases).

• Pass-Through Taxation: A mechanism where an entity (like a REIT, partnership, or LLC) doesn’t pay tax itself at the corporate level. Instead, it “passes through” its income to investors who then pay tax individually. REITs are pass-through entities – they avoid double taxation (no corporate tax + personal tax) and only incur tax at the investor level. This is why REIT yields can be higher – more of the profit is paid out to you, but you’re responsible for the tax on it.

• Form 1099-DIV: A tax form sent by your broker each year if you earned dividends. For REIT investors, this form is gold. It breaks your REIT dividends into components:

  • Ordinary Dividends (Box 1a): The portion of REIT distributions treated as ordinary income (taxable at regular rates).

  • Qualified Dividends (Box 1b): Likely zero for REITs, unless the REIT had a small part of dividends from a taxable subsidiary or something. Typically negligible for most REITs.

  • Total Capital Gain Distributions (Box 2a): Any portion of the REIT dividend that was a result of the REIT selling properties or assets at a profit and passing those gains to you. These are taxed at long-term capital gains rates (max 20%).

  • Nondividend Distributions (Box 3): This is the Return of Capital (ROC) portion. It’s not taxable as income when received; instead it reduces your cost basis in the stock.

  • There’s also Box 5 for “Section 199A Dividends” – which in the case of REITs is basically the amount of REIT dividends eligible for the 20% QBI deduction (often the same as the ordinary dividend amount for REITs).

• Return of Capital (ROC): Part of a distribution that is not from earnings but rather returning some of your invested capital. For REITs, ROC often comes from depreciation: real estate can generate cash flow that exceeds taxable income (because depreciation reduces taxable income). That excess gets paid out as dividends labeled “nondividend distribution” (ROC). It’s tax-free in the year you get it, but it lowers your cost basis. When you sell the investment, the ROC portions cumulated will result in a larger capital gain (or smaller loss) because your purchase price is effectively adjusted down. If you never sell and pass the shares to your heirs, those ROC adjustments can be wiped out by the basis step-up (a nice loophole for long-term holders).

• Tax Cuts and Jobs Act (TCJA) of 2017: A major tax law change that (among many things) introduced the Section 199A Qualified Business Income deduction for pass-through income. For REIT investors, this law made REIT dividends more attractive in taxable accounts by allowing a 20% deduction on REIT dividend income. Example: If you received $1,000 in REIT dividends (ordinary), you may deduct $200 on your tax return, so only $800 is taxed as ordinary income. This effectively lowers the tax rate on that income. Note: The TCJA’s individual provisions (including this deduction) are set to expire after 2025 unless extended.

• Section 199A / Qualified REIT Dividend: The formal term for REIT dividends that qualify for the 20% deduction. Don’t confuse this with “qualified dividend” (the special low-tax dividend type). Here, “qualified REIT dividend” just means it’s eligible for the 199A tax break. Nearly all REIT ordinary dividends are eligible for it (except any that are already treated as capital gain or qualified dividends).

• Net Investment Income Tax (NIIT): An extra 3.8% federal tax on investment income (including dividends and capital gains) for high-income individuals. It kicks in on MAGI above $200,000 (single) or $250,000 (married filing jointly). REIT dividends in taxable accounts count toward this. If you’re a high earner, your effective top federal tax on REIT income could be 37% + 3.8% = 40.8%. This is something to consider in the “worst-case” tax scenario for REITs in taxable.

• Residential vs. Commercial REITs: These terms refer to the type of real estate the REIT invests in. Residential REITs might own apartment complexes, student housing, single-family rentals, or mobile home parks – essentially places where people live. Commercial REITs own properties like office buildings, shopping malls, hotels, warehouses, data centers, or healthcare facilities. For our purposes, the distinction is more about investment focus; tax treatment is the same for both. However, different sectors can have different dividend yields and growth profiles. Residential REITs might be slightly more growth-oriented (lower yields, higher reinvestment) while some commercial REITs (like triple-net lease REITs or retail REITs) may have higher payout ratios and yields. But regardless of type, a $1 of ordinary dividend from a residential REIT is taxed no differently than $1 from a commercial REIT in your taxable account.

• Mortgage REIT (mREIT): A special breed of REIT that doesn’t own properties but invests in mortgages or mortgage-backed securities. mREITs often have very high yields (sometimes 8-12%) but their dividends come from interest payments, which are fully taxable as ordinary income (with 199A deduction applicable). They also typically have little to no ROC component because they aren’t depreciating physical properties. If anything, mREIT dividends are even more tax-heavy, making them prime candidates for tax-advantaged accounts if possible.

Now that we have the terminology down, let’s illustrate how all this plays out in real life with some examples.

🏘️ Detailed Real-World Examples: REITs in Taxable Scenarios

To answer our question, it helps to see numbers. Let’s walk through a few common scenarios that investors might encounter when holding REITs in a taxable account. These examples will show how taxes can vary depending on your income level and the REIT’s characteristics:

Example 1: High-Earner with a REIT in Taxable
Meet Alice, a high-income professional in the 37% federal tax bracket (and subject to the 3.8% NIIT). Alice holds $10,000 worth of a commercial REIT in a taxable brokerage account. The REIT yields 5%, so in a year it pays $500 in dividends to Alice. Let’s say the REIT’s dividends are typical: 100% ordinary taxable income (no ROC this year, no special capital gains distribution). How much tax does Alice owe on that $500?

• Federal ordinary income tax: 37% of $500 = $185.

• 199A deduction benefit: She can deduct 20% of the $500 = $100 on her tax return. So actually, only $400 is taxed at 37%, which is $148 in federal tax.

• NIIT: $500 * 3.8% = $19 (because Alice’s income is high enough for this surtax).

• State tax: Alice lives in a state with a 5% income tax. That’s another $25 on the full $500.

• Total tax on $500: ~$148 + $19 + $25 = $192. Ouch! This effective rate of ~38.4% means Alice keeps only about $308 of the $500 dividend after taxes.

Now imagine Alice instead held that REIT in her traditional 401(k). She would owe $0 tax on the $500 this year; it would all reinvest. True, when she withdraws in retirement it’ll be taxed as ordinary income, but she’s deferring taxes for years (and maybe at a lower bracket later). If it were in a Roth IRA, she’d never pay a cent on those dividends. Clearly, for someone like Alice, holding the REIT in a taxable account is costly.

Example 2: Mid-Income Investor, Limited IRA Space
Now consider Brian, who is in the 22% federal tax bracket (no NIIT, moderate income). Brian also has $10,000 in a REIT fund (let’s say a residential REIT ETF) in a taxable account, yielding 5% ($500 dividends). His IRA is already filled with bonds, so he put his REIT in taxable by necessity. Here’s Brian’s tax picture:

• Federal tax on $500: 22% * $500 = $110.

• 199A deduction: He deducts $100 (20%), leaving $400 taxable at 22%, which is $88.

• NIIT: Not applicable (income below threshold).

• State tax: He’s in a no-income-tax state (Florida), so $0 state tax.

• Total tax: about $88, which is roughly 17.6% of the $500.

Brian pays a significant, but not crippling, tax on his REIT income. He effectively nets $412 after tax from the $500. If this REIT was in a taxable bond fund instead, he’d actually pay a bit more tax (because bond interest doesn’t get the 20% deduction). And a stock with $500 in qualified dividends would only cost him $75 in tax (15% of $500) at his bracket. Brian decides that, while not perfect, holding REITs in taxable is acceptable for him since he wants real estate exposure and has no other account room. He also plans to reinvest the remaining $412 and hold the REIT for a long time.

Example 3: REIT with Return of Capital – Tax Deferral
Finally, meet Carol. She owns shares in a specialty REIT that invests in residential apartments and benefits from heavy depreciation. It yields 5% ($500 on her $10k investment), but this year, half of that was classified as return of capital! So, $250 is ROC and $250 is ordinary taxable dividend. Carol is in the 24% bracket.

• Taxable portion: $250 is ordinary. With the 20% deduction, only $200 is taxed at 24%, so $48 federal tax.

• ROC portion: $250 is not taxed this year. Carol’s cost basis in the REIT stock is reduced by $250.

• Total tax this year: just $48, under 10% effective on the full $500 cash she received.

Carol is pleased – her REIT’s tax-efficient distribution means she keeps $452 out of $500 after federal tax (and she’s in a state with no income tax as well). However, she knows this isn’t “free money.” The $250 ROC will eventually be taxed when she sells the shares (likely as a capital gain). If she holds the investment for many years, that deferred tax might be at the 15% long-term capital gains rate, costing about $37.5 in tax down the road. Even so, paying $48 now and $37.5 later (present value considered) is better than paying the whole amount upfront. Carol also has a plan: she might hold these shares until she passes them to her children. If the law still allows a step-up in basis at that time, that $250 of deferred gains could become permanently untaxed.

These examples highlight how the impact of holding a REIT in a taxable account can range from punitive (Alice’s case) to tolerable (Brian’s case) to relatively efficient (Carol’s case) – depending on tax brackets and the REIT’s own distributions.

Let’s summarize these three scenarios:

As you see, holding REITs in taxable can yield very different outcomes. The worst case is a high-bracket situation, which strongly argues for using a tax-advantaged account. More middle-of-the-road cases might be manageable, especially if you exploit tax breaks (199A deduction, ROC deferral).

Now that we’ve seen examples, let’s dig deeper into why REITs are taxed the way they are and compare this with other investments you could hold in a taxable account.

🔬 Supporting Evidence & Tax Mechanics: Why REITs Face Heavy Taxation

To fully answer whether REITs belong in a taxable account, you need to understand how REIT taxation works. Let’s break down the tax mechanics and some key evidence from tax law:

• REITs must pay out earnings: Under federal law, a REIT is required to distribute at least 90% of its taxable income to shareholders annually. In practice, many REITs pay out 100% or more (using cash flow in excess of taxable income, thanks to depreciation). This ensures investors get a high yield, but it also means a steady stream of taxable income if held in a regular account. Unlike a growth stock that might retain profits (and you only get taxed when you sell shares), a REIT forces you to take income each year.

• No corporate tax (pass-through): Why do REITs get this special treatment? They were created (back in 1960) to allow everyday investors to invest in large-scale real estate and receive income without double taxation. A regular C-corporation pays corporate tax (21% federal rate currently) on its profits, then if it pays dividends, those dividends may be taxed again at the shareholder level. REITs avoid the first layer – they generally pay zero corporate tax if they meet the payout requirement. So the full burden of tax is on the investor’s shoulders. The upside: more of the REIT’s pre-tax profits flow to you (which is part of why REIT yields are often higher than many stocks’ yields).

• Ordinary income nature: Because the REIT isn’t taxed as a corporation, its dividends don’t meet the criteria to be “qualified dividends.” The IRS essentially looks at REIT dividends as if you earned the rental income or interest directly. That means taxing it at your normal income rate, not the preferred dividend rate. As noted earlier, the majority of REIT dividend dollars across the industry fall into this bucket of ordinary income.

• 20% QBI deduction for REIT dividends: Thankfully, since 2018, investors have a bit of relief. The Section 199A Qualified Business Income deduction (a product of the Tax Cuts and Jobs Act) allows you to deduct 20% of your REIT ordinary dividends when calculating taxable income. Practically, this means if you’re in the top 37% bracket, your effective rate on REIT dividends drops to 29.6%. If you’re in the 24% bracket, it effectively becomes ~19.2%, and so on. Important: This deduction is set to expire after 2025, unless extended. If it lapses, REIT dividends become slightly less attractive in taxable accounts going forward (back to being fully taxed at ordinary rates).

• Capital gains distributions: Sometimes a REIT will sell a property it has held for many years. When that happens, any gain it realizes (assuming the property was held over a year) can be passed to shareholders as a capital gains distribution. These are reported on that 1099-DIV (Box 2a) and taxed at long-term capital gains rates (currently max 20% federally, plus NIIT potentially). Capital gain distributions from REITs are treated just like capital gain distributions from mutual funds – they get the preferential rate. However, not all REITs regularly make such distributions; many try to keep properties or use 1031 exchanges to defer gains at the corporate level. But if you see one, know it’s taxed more favorably.

• Return of Capital effects: As highlighted in Example 3, a portion of REIT payouts might be categorized as return of capital. For example, in 2022, some large equity REITs had 10-20% of their dividends as ROC. This part is great in the short term – you pay no tax on it immediately. It effectively defers tax until you sell the stock. The flip side is if you hold the REIT long enough that your cumulative ROC equals your initial investment, any further ROC becomes immediate capital gains (once your basis hits zero). That’s rare unless you hold for decades and the REIT keeps paying a high ROC percentage. Most investors will likely sell or have some cost basis remaining. The tax mechanic here is similar to what happens in Master Limited Partnerships (MLPs) or other pass-throughs: depreciation shields some income, turning it into deferred income. Just keep records and remember it’s not tax-free forever (unless you manage to step-up the basis at inheritance).

• Form 1099-DIV and record-keeping: Each year, the breakdown of your REIT’s dividend is determined by the REIT’s accountants and communicated via the 1099-DIV. They often announce this info in January. For instance, a REIT might declare that “of the $2.50 per share distributed last year, $2.00 is ordinary (Section 199A) dividend, $0.30 is return of capital, and $0.20 is long-term capital gain.” As an investor, you don’t need to guess – the forms do it for you. But you do need to put the right numbers on your tax return. If using tax software, ensure the 1099-DIV is entered correctly so the software applies the lower rates and deductions accordingly.

• State tax nuances: On the state level, almost all states tax dividends (qualified or not) as part of your income, without any lower rate distinction. A few states have exclusions for certain capital gains or dividends, but generally, assume your REIT income adds to state taxable income. The exceptions are if you live in a state with no income tax (then no state tax on dividends) or a state that specifically exempts some kinds of investment income (rare for REIT dividends specifically). Additionally, a couple of states used to have special taxes on investment income (like Tennessee’s now-phased-out Hall Tax), but as of 2025 there’s no broad state-level preferential rate for dividends in most places. So plan on that ordinary state rate hit if applicable.

• International considerations: If you’re investing in foreign REITs or global real estate funds, note that other countries might withhold taxes on REIT dividends. For example, a Singapore or Canadian REIT might withhold a percentage before you even get the dividend (though you can often claim a foreign tax credit). This goes beyond our main scope, but just be aware that the taxation can get even more complex with international REITs in a taxable U.S. account.

• Evidence in performance: Studies and expert recommendations often classify REITs as “tax-inefficient” investments. For example, if you read white papers on asset location, REITs and taxable bonds usually top the list of assets to put in an IRA. The logic is straightforward: if an asset throws off a lot of taxable income each year, shelter it if you can. Conversely, assets that mainly appreciate without much current income (like growth stocks) are fine in taxable. Historical data shows that a significant portion of REIT total returns comes from dividends (sometimes 50% or more of long-term REIT returns are from reinvested dividends). Paying tax on those every year can substantially reduce your ending wealth versus if those dividends compounded tax-free.

Now, having covered the mechanics and why REITs are taxed the way they are, let’s answer the natural follow-up: how do REITs compare to other investment options in a taxable account? Are they really that much worse, or are there cases where they might actually be on par or better?

⚖️ REITs vs. Other Asset Classes in a Taxable Account

Investors often need to decide which investments to place in taxable vs. tax-advantaged accounts. Let’s compare REITs with other common asset classes when held in a taxable account, focusing on tax efficiency and suitability:

REITs vs. Stocks (Equities) in Taxable Accounts

Taxation: Regular stocks (outside of REITs) often pay qualified dividends or sometimes no dividends at all (for growth stocks). Qualified dividends get that sweet 0-15-20% tax rate. Also, much of a stock’s return might come as capital appreciation, which isn’t taxed until you sell. And if you hold the stock over a year, any gain is a long-term capital gain taxed at max 15-20% for most investors.

Example: Suppose you invest $10,000 in a dividend-paying stock fund yielding 2%. You’d get $200 in dividends yearly, taxed at 15% = $30 tax (if you’re in a moderate bracket). The rest of the stock’s returns maybe come as a 5% price increase ($500) which you don’t realize annually. You decide to hold long-term and maybe only pay capital gains tax far in the future, or you can strategically harvest gains up to the 0% bracket if you’re in a low-income year. In contrast, a $10,000 investment in a REIT yielding 5% gives $500 fully (mostly) taxable each year. Even with the 20% deduction, a moderate bracket investor might pay ~$88 (as we saw with Brian) or a high bracket investor ~$150-$200 on that (like Alice).

Outcome: Stocks are usually more tax-efficient in taxable accounts. You have control over when to realize taxes (by selling), and the ongoing dividends are either lower or taxed at preferential rates. This is why many professionals say: put your stock index funds in taxable, and your REITs in tax-deferred accounts if possible.

Exception – Low Dividend Stocks: If a stock pays no dividend (like some growth tech stock), it might generate zero taxable income until you sell. Such assets are extremely tax-efficient in a taxable account. REITs, by design, will always pay dividends annually. So for maximum compounding with no drag, equities win in taxable.

Exception – Tax-Managed Funds: Some stock funds or ETFs are designed to minimize distributions (like tax-managed mutual funds or ETFs that avoid capital gains). These can be held in taxable with minimal tax impact year to year. Again, REIT funds can’t really avoid distributing income, so they’ll never be as tax-light as these.

REITs vs. Bonds in Taxable Accounts

Taxation: Bond interest from corporate or U.S. Treasury bonds is taxed as ordinary income (just like REIT dividends, actually). There’s no special rate for interest. So on the surface, holding a bond fund in taxable can be just as bad as a REIT from a tax standpoint – both are ordinary income generators.

Key differences:

• Yield levels: Right now, interest rates are higher than they’ve been in years. A corporate bond fund might yield ~4-5%. A REIT might yield similar 4-5%. Both would generate similar taxable income per $ invested.

• Tax breaks: Bond interest doesn’t get the 20% QBI deduction. REIT dividends do. That means at equal yields, the REIT could actually result in a lower effective tax rate. E.g., $500 interest taxed at 24% = $120 tax, whereas $500 REIT dividend taxed at 19.2% effective (after deduction) = $96 tax.

• Return of capital: Bonds don’t have ROC or any tax deferral on interest (except certain structured products or OID complexities, but typically no). REITs might have some ROC. So again, potentially a portion of REIT income might be deferred vs bond interest is fully taxed immediately.

Munis: If we include municipal bonds, those are a different beast – muni interest is tax-free federally (and state-free if you buy in-state munis). So munis can be very tax-efficient for high earners (though yields are usually lower to begin with). Comparing a muni yielding 3% tax-free to a REIT yielding 5% taxable: if you’re in the 37% bracket, the 5% REIT nets ~3.15% after fed tax (5% * (1-0.37) = 3.15%), whereas the muni’s 3% is 3% after tax. Add state tax, etc., it could tilt in favor of the muni for high-tax individuals seeking income.

Outcome: Taxable bonds and REITs are both generally poor fits for taxable accounts, with a slight edge to REITs for the 20% deduction and potential ROC. Most advisors would say keep both your REIT funds and your bond funds in tax-advantaged accounts if you can. If you have to hold one of these in taxable, consider your needs: If you need stability and low volatility, you might tolerate the tax on bonds in taxable. If you need higher income and can manage the volatility, a REIT in taxable might be comparable or slightly better after tax due to the deduction. Also consider muni bonds in taxable as an alternative to both, if you’re in a high bracket (essentially swapping taxable income for lower, tax-free income).

REITs vs. Master Limited Partnerships (MLPs) & Other High-Yield Pass-Throughs

Taxation: MLPs (common in energy infrastructure, for instance) also avoid corporate tax and pass through income (and loss) to investors. MLP distributions are famous for being largely tax-deferred return of capital (sometimes 80-90% ROC), due to heavy depreciation on pipelines etc. This means you might get a high yield with very little immediate tax, much like Carol’s scenario or even more extreme. The catch: you get a complicated K-1 form instead of a 1099, and when you sell, you have to recapture depreciation (some of the gain taxed as ordinary). MLPs also can trigger UBTI (Unrelated Business Taxable Income) if held in an IRA, which can be a headache.

Comparison: REITs are simpler (1099 forms, no UBTI issues in IRAs). In taxable accounts, an MLP might deliver more tax deferral than a REIT due to larger ROC, but eventually the tax comes due at sale and part of it at ordinary rates (depreciation recapture rules). It’s a complex trade-off. If one is comfortable with K-1 forms and long holding periods, MLPs in taxable can be quite tax-efficient (sometimes more than REITs). However, because of the complexity, many stick with REITs or other simpler structures.

Other pass-throughs: Some funds (like certain private real estate funds or BDCs) also have high yields taxed as ordinary income. BDCs (Business Development Companies) issue 1099s but their dividends are mostly non-qualified (ordinary income). These, like REITs, often best belong in IRAs if possible due to high taxable yields.

REITs vs. Direct Real Estate Ownership (Rental Properties)

This isn’t an “asset in a taxable account” per se – if you own a rental property outright, all its income is taxable but you have a lot of control through deductions. It’s worth a brief mention:

• Rental income can be sheltered by depreciation and expenses. Often investors show little taxable income in early years of a property because depreciation (a paper expense) offsets it.

• When you sell a property, you can use a 1031 exchange to defer capital gains by buying another property.

• There’s no easy “IRA” for direct real estate (except using a self-directed IRA which is advanced and has its own rules). So most rental property investing is inherently in “taxable world,” but it comes with its own set of tax benefits (and also the ability to leverage, etc.).

Comparison: REITs give you passive, hands-off exposure, but you don’t get to personally write off the depreciation – the REIT does and uses it to classify part of your dividend as ROC. Direct ownership gives you active control of tax strategy but at the cost of effort and illiquidity. This is a bit apples-to-oranges, but the point is, REITs in taxable accounts behave differently tax-wise than owning a duplex and renting it out, even though both derive from real estate. A savvy investor might do both: use REITs in IRAs for hassle-free diversification, and own a rental property for additional benefits.

To crystallize the comparison of various assets in taxable accounts, here’s a handy table:

From the above, you can see that compared to many alternatives, REITs generally fall on the less efficient side for taxable holdings. Stocks and index funds shine in taxable accounts, while REITs and bonds prefer the cozy shelter of IRAs.

However, remember investing is about the overall portfolio. You might still hold some REITs in taxable if you want the asset class exposure and can’t fit it all in an IRA. Just go in with eyes open, utilize the tax breaks available, and consider the after-tax return in your strategy.

🧐 Frequently Asked Questions (FAQ) about REITs in Taxable Accounts

Q: Can I hold REITs in a Roth IRA, and is it better than holding them in taxable?
A: Yes. A Roth IRA is ideal for REITs – you pay no taxes on dividends or gains, ever. That’s better than a taxable account, where REIT income gets taxed every year.

Q: What portion of REIT dividends is taxable versus not?
A: Varies by REIT and year. Majority is typically taxable ordinary income. Some portion (often 0-30%) may be return of capital (tax-deferred), and sometimes a small percentage is taxed as long-term capital gain.

Q: Do REIT ETFs or mutual funds have the same tax issues?
A: Yes. REIT mutual funds and ETFs pass through income, so their taxable account distributions are taxed the same as holding individual REITs (mostly as ordinary income with some possible capital gain or ROC components).

Q: Did the Tax Cuts and Jobs Act change how REITs are taxed?
A: Yes. The 2017 Tax Cuts and Jobs Act created a 20% deduction for REIT dividends (through 2025), lowering the effective tax rate on REIT income in taxable accounts.

Q: I only have a taxable account (no IRA/401k). Should I avoid REITs altogether?
A: Not entirely. You can invest in REITs for diversification and income, but be mindful of taxes. Prefer REITs with tax-deferred ROC, reinvest dividends, and monitor your tax bracket to avoid surprises.

Q: How are REIT dividends reported during tax filing?
A: On Form 1099-DIV. Enter ordinary REIT dividends as taxable income. Qualified and capital gain portions (if any) get lower capital gains tax rates. Don’t report return of capital as income; instead, reduce your cost basis.

Q: Are there any states that don’t tax REIT dividends?
A: States with no income tax (like Florida, Texas, Nevada, etc.) won’t tax your REIT dividends. Otherwise, most states tax dividend income as ordinary income, so expect state tax unless you’re in a no-tax state.

Q: What’s the best strategy for holding REITs given taxes?
A: Use smart asset location: keep REITs in IRA/401k accounts if possible to defer or avoid taxes. If held in taxable, reinvest after-tax dividends, exploit the 20% deduction, harvest losses, and consider high-ROC REITs for tax deferral.