REIT
REIT
Real Estate Investment Trust. a company that owns, operates, or finances income-producing real estate. Must distribute at least 90% of taxable income as dividends to shareholders to maintain pass-through tax status. Two main types: equity REITs (own properties) and mortgage REITs (lend money for mortgages). REIT dividends are taxed as ordinary income.
A client allocates 10% of their portfolio to a publicly-traded equity REIT that owns apartment buildings and shopping centers. The REIT generates rental income and distributes 95% to shareholders as monthly dividends, providing income and inflation hedge through real estate exposure without direct property ownership.
Students often confuse equity REITs (which own physical properties) with mortgage REITs (which hold mortgages and mortgage-backed securities). Another common error is thinking REIT dividends qualify for preferential dividend tax rates; they are taxed as ordinary income. REITs provide real estate exposure but not direct property ownership.
How This Is Tested
- Identifying the 90% minimum distribution requirement for REIT tax qualification
- Distinguishing between equity REITs (own properties) and mortgage REITs (lend for mortgages)
- Understanding that REIT dividends are taxed as ordinary income, not qualified dividend rates
- Recognizing REITs as suitable for income needs, inflation hedging, and portfolio diversification
- Understanding REITs provide real estate exposure with liquidity advantages over direct ownership
Regulatory Limits
| Description | Limit | Notes |
|---|---|---|
| Minimum distribution requirement | 90% of taxable income | Must distribute annually to shareholders to maintain pass-through tax status |
| Asset composition requirement | 75% of assets in real estate | At least 75% of total assets must be in real estate assets, cash, or government securities |
| Income source requirement | 75% of gross income from real estate | At least 75% of gross income must come from rents, mortgage interest, or property sales |
Example Exam Questions
Test your understanding with these practice questions. Select an answer to see the explanation.
Patricia, age 62, is a retired teacher receiving a pension of $48,000 annually. She has $400,000 in a taxable brokerage account currently invested 100% in growth stocks. She is concerned about inflation eroding her purchasing power and wants more current income without taking on excessive risk. She is in the 24% tax bracket. Which of the following recommendations would be most appropriate?
A is correct. A modest 10-15% allocation to a diversified equity REIT addresses Patricia's needs for current income (REITs typically yield 3-5% from their 90%+ distribution requirement) and inflation protection (real estate values and rents tend to rise with inflation). This provides diversification away from pure equity exposure without creating excessive concentration in real estate.
B is incorrect because REITs do not have credit risk in the traditional sense. Equity REITs own physical properties, not debt. The statement confuses REITs with mortgage REITs or bonds. Maintaining 100% growth stocks does not address her income needs. C is incorrect because a 50% allocation to mortgage REITs would be far too concentrated and aggressive. Mortgage REITs are more volatile and interest-rate sensitive than equity REITs. D is incorrect because while REIT dividends are taxed as ordinary income (not qualified dividends), dismissing REITs entirely ignores their diversification and inflation-hedging benefits. The income and inflation protection may outweigh the tax disadvantage.
The Series 65 exam tests your ability to recognize when REITs are suitable investments based on client needs. REITs work well for income-focused investors, inflation hedging, and portfolio diversification. Understanding the 90% distribution requirement explains why REITs generate substantial income. You must also know that REIT dividends face ordinary income tax rates, which matters for tax-sensitive clients in high brackets.
To maintain favorable tax treatment and avoid corporate-level taxation, a Real Estate Investment Trust (REIT) must distribute what percentage of its taxable income to shareholders?
C is correct. REITs must distribute at least 90% of their taxable income to shareholders annually to maintain their special tax status as a pass-through entity and avoid paying corporate income tax. This high distribution requirement makes REITs attractive for income-focused investors but limits the REIT's ability to retain earnings for growth.
A (50%) is incorrect because this is far below the actual requirement and would not qualify the REIT for pass-through taxation. B (70%) is incorrect. While 75% relates to REIT asset composition requirements (75% of assets in real estate), it is not the distribution requirement. D (100%) is incorrect because REITs are not required to distribute all income, just 90% or more. Retaining up to 10% allows some flexibility for operations and growth.
The 90% distribution requirement is one of the most frequently tested REIT characteristics on the Series 65. This rule explains why REITs typically offer high dividend yields (3-5% or higher) compared to regular stocks, making them suitable for income-seeking clients. However, you must also know that REIT dividends are taxed as ordinary income, not at the preferential qualified dividend rate.
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Access Free BetaA REIT has $50 million in taxable income for the year. To maintain its pass-through tax status, the REIT must distribute at least 90% to shareholders. If the REIT has 10 million shares outstanding and distributes exactly the minimum required amount, what is the dividend per share?
B is correct. Calculate: Minimum required distribution = $50 million × 90% = $45 million. Dividend per share = $45 million ÷ 10 million shares = $4.50 per share.
A ($4.00 per share) incorrectly uses 80% distribution ($40 million ÷ 10 million shares), which would be below the 90% requirement. C ($5.00 per share) incorrectly distributes 100% of taxable income ($50 million ÷ 10 million shares), which exceeds the minimum requirement. While REITs can distribute 100%, the question asks for the minimum. D ($5.50 per share) incorrectly calculates 110% distribution ($55 million ÷ 10 million shares), which is mathematically impossible without additional sources of distributable funds beyond taxable income.
REIT distribution calculations test your understanding of the 90% minimum requirement and your ability to compute per-share dividends. The Series 65 exam uses these calculations to verify you understand both the regulatory threshold and the income implications for investors. Remember that most REITs distribute more than 90% in practice (often 95-100%), but the legal minimum is 90%.
All of the following statements about REITs are accurate EXCEPT
C is correct (the EXCEPT answer). REITs do NOT provide direct ownership of real estate to shareholders. Shareholders own shares in the REIT company, which itself owns the properties. This is an indirect ownership structure similar to owning mutual fund shares rather than the underlying securities directly. Shareholders have no control over property management decisions or direct legal title to properties.
A is accurate: the 90% distribution requirement is the key tax rule allowing REITs to avoid corporate income tax at the entity level. B is accurate: REIT dividends are taxed as ordinary income, which is a disadvantage compared to qualified dividends from corporations (taxed at 0%, 15%, or 20% depending on income). D is accurate: publicly-traded REITs offer superior liquidity compared to owning physical real estate, which can take months to sell and involves high transaction costs.
The Series 65 exam tests whether you understand the ownership structure of REITs versus direct real estate. This distinction matters for suitability discussions. clients seeking direct property control, depreciation benefits, or property management involvement should not invest in REITs. REITs are passive investments providing exposure to real estate returns without management responsibilities or direct ownership rights.
An investment adviser is evaluating whether to recommend a publicly-traded equity REIT to a 55-year-old client with a moderate risk tolerance seeking portfolio diversification and income. The client currently holds 70% stocks, 25% bonds, and 5% cash. Which of the following statements support adding a REIT allocation?
1. REITs provide diversification because real estate returns have low correlation with stocks and bonds
2. REITs offer liquidity advantages over direct real estate ownership
3. REITs provide an inflation hedge as property values and rents tend to rise with inflation
4. REIT dividends receive preferential qualified dividend tax treatment
C is correct. Statements 1, 2, and 3 support adding a REIT allocation.
Statement 1 is TRUE: Real estate has historically shown low or moderate correlation with traditional stocks and bonds, making REITs an effective diversification tool. Adding a REIT allocation to a stock/bond portfolio reduces overall portfolio volatility.
Statement 2 is TRUE: Publicly-traded REITs offer daily liquidity through exchange trading, unlike direct real estate ownership which requires months to sell and involves high transaction costs (agent commissions, closing costs). This liquidity advantage makes REITs more suitable for investors who may need access to capital.
Statement 3 is TRUE: Real estate serves as an inflation hedge because property values and rental income tend to increase during inflationary periods. As costs rise, landlords can raise rents, protecting purchasing power. This makes REITs attractive for inflation-concerned investors.
Statement 4 is FALSE: REIT dividends are taxed as ordinary income (at rates up to 37%), NOT at the preferential qualified dividend rates (0%, 15%, or 20%). This is a tax disadvantage of REITs and does not support the recommendation, though it does not necessarily eliminate REITs from consideration if other benefits outweigh the tax treatment.
The Series 65 exam tests comprehensive understanding of REIT characteristics and suitability. You must know the benefits (diversification, liquidity, inflation protection, income) and drawbacks (ordinary income tax treatment, interest rate sensitivity, no retained earnings for growth). Questions often require evaluating multiple factors simultaneously to determine overall suitability. Understanding correlation, inflation hedging, and tax treatment are all essential concepts that appear in REIT questions.
💡 Memory Aid
Remember "REIT = Real Estate without the hassle": You get property exposure and income (90%+ distributions) without managing toilets, tenants, or trash. But watch out: Regular Income Tax applies (not the sweet qualified dividend rates). Think "REIT = RENT payments to you monthly."
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Where This Appears on the Exam
This term is tested in the following Series 65 exam topics: