REIT Dividends – Impact of Recent Tax Legislation

The Qualified Business Income (QBI) deduction, also known as the Section 199A tax deduction, has generated a tax advantage for certain Real Estate Investment Trust (REIT) investors since its introduction under the Tax Cuts and Jobs Act (TCJA) of 2017. Originally set to expire after December 31, 2025, the deduction’s future was uncertain until the July 4 passing of a new tax reconciliation law, which made this deduction permanent. Here’s what REIT investors need to know about this extension and how it affects their portfolios.

What Is the Section 199A Deduction?

The Section 199A deduction allows eligible taxpayers to deduct up to 20% of their qualified business income (QBI) from pass-through entities like sole proprietorships, partnerships, and S corporations. Crucially for REIT investors, it also applies to qualified REIT dividends—those dividends reported by REITs as eligible for the deduction on Form 1099-DIV, Box 5. This provision reduces the effective tax rate on REIT dividends, which are typically taxed at ordinary income rates, making REITs a more attractive investment for income-focused portfolios.

Why the Extension Matters for REIT Investors

The extension of the Section 199A deduction ensures that REIT investors continue to benefit from this tax break indefinitely. Here’s why this matters:

1. Enhanced After-Tax Returns: The 20% deduction on qualified REIT dividends lowers the effective tax rate, increasing after-tax yields. For example, an investor in the 37% tax bracket receiving $100,000 in qualified REIT dividends could deduct $20,000, reducing taxable income and saving $7,400 in taxes. This makes REITs more competitive with other income-producing assets like bonds or dividend-paying stocks.
2. Stability for Long-Term Planning: The extension provides certainty for investors planning their portfolios. Knowing the deduction will persist allows for more confident allocation to REITs in taxable accounts, where the tax benefit is most impactful.
3. No Phase Outs Based on Income for REIT Dividend Deduction: Section199A enacts phase-out’s for pass-through businesses based on taxable income hurdles. However, qualified REIT dividends are not subject to these W-2 wage or income limitations, making the deduction more straightforward for REIT investors.
4. Benefits for Taxable Accounts: The deduction is most valuable in taxable brokerage accounts, where REIT dividends are subject to ordinary income tax rates. Investors holding REITs in tax-advantaged accounts like IRAs or 401(k)s won’t directly benefit from the deduction, but those in taxable accounts will see tax savings.
5. State Income Tax Benefits: REITs are taxed as corporations. Since REIT distributions are considered dividends, investors no longer have to file taxes in the state the funds does business in; rather, they only need to file in their state of residence.
6. UBTI Blocker for Retirement Accounts: REITs offer advantages for retirement account investors, including protection from Unrelated Business Taxable Income (UBTI). In a REIT environment, UBTI is no longer applicable regardless of how levered the fund is because the REIT is taxed as a corporation, which acts as a UBTI blocker.

What Qualifies as a “Qualified REIT Dividend”?

Not all REIT dividends are eligible for the Section 199A deduction. Qualified REIT dividends are those reported in Box 5 of Form 1099-DIV as “Section 199A dividends.” The IRS defines “qualified REIT dividends” as dividends from a REIT that are not classified as capital gain dividends or qualified dividends under Internal Revenue Code Section 1(h)(11). These are eligible for the 20% deduction under Section 199A. Investors must review their 1099-DIV forms carefully to identify eligible amounts. Ask the fund administrator of your REIT if their dividends qualify for 199A deduction.

About Bridger Fund

Bridger Fund is a California-based mortgage REIT which distributes monthly dividends from senior commercial real estate notes qualified for the 199A Deduction. If you have questions or interest in an LP position in Bridger Fund, please request a prospectus at spence.sarazin@bridgerfund.com.