REITs and Tax Efficiency

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centennialstate
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REITs and Tax Efficiency

Post by centennialstate » Fri May 22, 2020 10:34 am

A. Why are REITs tax-inefficient? Does it have something to do with the way cash flows work in the business? Or the high dividends?

B. Are there other market sectors that are similarly tax-inefficient?
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arcticpineapplecorp.
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Re: REITs and Tax Efficiency

Post by arcticpineapplecorp. » Fri May 22, 2020 10:39 am

centennialstate wrote:
Fri May 22, 2020 10:34 am
A. Why are REITs tax-inefficient? Does it have something to do with the way cash flows work in the business? Or the high dividends?

B. Are there other market sectors that are similarly tax-inefficient?
usually 90% of the profits of REITS have to be returned to investors in the form of dividends. Since dividends are taxed at a higher rate generally than capital gains, you don't want to generate a lot of dividend income in a taxable accounts. Because then you're just creating a taxable event. Look at "investment taxes" here: https://www.bogleheads.org/wiki/Outline ... _investors

They're more suitable for tax advantaged accounts (401ks/IRAs).

here's some guidance on tax efficient placement of mutual funds:
https://www.bogleheads.org/wiki/Tax-eff ... _placement

lots of good info at the wiki. check it out.
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abuss368
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Re: REITs and Tax Efficiency

Post by abuss368 » Fri May 22, 2020 10:47 am

centennialstate wrote:
Fri May 22, 2020 10:34 am
A. Why are REITs tax-inefficient? Does it have something to do with the way cash flows work in the business? Or the high dividends?

B. Are there other market sectors that are similarly tax-inefficient?
REITs are not as tax efficient as some alternative investments but they also are not tax inefficient.

The "dividend" from REITs typically is comprised of three subcomponents: 1) the actual dividend - taxed at ordinary income tax rates, 2) capital gain - taxed at lower preferred rates, and 3) a return of capital - which is not taxed and reduces cost basis (taxed if cost basis ever goes below zero). A Form 1099 at year reports this activity and it is quite easy.

The Trump 2017 Tax Act also provided an additional QBI deduction on REIT dividends by 20%. This has changed a lot as well.

I know someone who retired early with REITs in both taxable and tax advantaged account - 45,000 shares and is loving the income!
John C. Bogle: Two Fund Portfolio - Total Stock & Total Bond - “Simplicity is the master key to financial success."

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