The 90% rule for Real Estate Investment Trusts (REITs) is a fundamental requirement that mandates these companies distribute at least 90% of their taxable income to shareholders annually in the form of dividends. This critical provision allows REITs to avoid corporate income tax, making them a unique investment vehicle designed to provide income-generating real estate exposure to investors without the need to buy, manage, or finance properties directly.
Understanding the REIT 90% Distribution Rule
At its core, the 90% rule is the cornerstone of a REIT's special tax status. Unlike traditional corporations, which face corporate income tax on their profits before distributing dividends to shareholders (who then pay individual income tax on those dividends), REITs largely bypass this "double taxation." By distributing the vast majority of their taxable income, REITs act as pass-through entities, meaning the income is taxed only once at the shareholder level.
This rule emphasizes the income-generating nature of REITs. It ensures that a significant portion of the profits generated from their real estate investments directly flows back to investors, making them attractive for those seeking regular income streams.
Key Requirements for REIT Qualification
To qualify as a REIT and benefit from the associated tax advantages, a company must adhere to several criteria beyond the 90% distribution rule. These requirements ensure that the entity primarily operates as a real estate investment vehicle.
Here’s a summary of key qualifications, including the elements from the 90% rule:
| Requirement Category | Specific Rule | Description |
|---|---|---|
| Income Distribution | 90% Rule | Must distribute at least 90% of taxable income to shareholders annually as dividends. |
| Asset Connection | Bulk of Assets | At least 75% of total assets must be real estate assets (e.g., real property, mortgages). |
| Income Source | Bulk of Income | At least 75% of gross income must be derived from real estate-related sources (e.g., rents from real property, interest on mortgages, gains from real estate sales). |
| Organizational Structure | Managed by Trustees | Managed by a board of directors or trustees. |
| Shareholder Base | Minimum Shareholders | Must be owned by at least 100 different shareholders. |
| Diversification | 5/50 Rule | No more than 50% of its shares can be owned by five or fewer individuals during the last half of the taxable year. |
Note: The "bulk of its assets and income connected to real estate investment" directly refers to the 75% asset and income tests, which complement the 90% distribution rule.
Implications for Investors
The 90% rule has significant implications for investors considering REITs for their portfolios:
- Consistent Income Stream: Investors typically receive regular dividend payments, often quarterly, making REITs a popular choice for income-focused portfolios.
- Taxation of Dividends: While REITs avoid corporate tax, the dividends received by shareholders are generally taxed as ordinary income, not as qualified dividends (which often receive preferential tax treatment). This means they are taxed at your marginal income tax rate.
- Lower Retained Earnings for Growth: Because REITs distribute most of their income, they retain less capital for internal growth or new property acquisitions. This often means they rely more on external financing (issuing new equity or debt) to fund expansion.
- Transparency: The high distribution requirement can make a REIT's financial health and operational efficiency more transparent, as most of their earnings are passed through.
Why the 90% Rule is Beneficial
The 90% rule serves several purposes, benefiting both the REIT structure and its investors:
- For REITs: It grants them exemption from corporate income tax, allowing more capital to flow through to investors. This makes REITs a more efficient way to invest in large-scale real estate.
- For Shareholders: It ensures that investors receive a substantial portion of the REIT's earnings, providing a predictable and often high-yielding income stream. It aligns the interests of the REIT management with that of the shareholders, as earnings must be passed on.
- Market Access: The REIT structure makes it easy for individual investors to participate in large-scale, income-producing real estate ventures that would otherwise be inaccessible.
For more information on REITs, you can explore resources from the U.S. Securities and Exchange Commission (SEC) or financial education sites like Investopedia's guide to REITs.
