Real Estate Investment Trusts, commonly referred to as REITs, are popular with many individual investors because REITs pay generous dividend yields compared to some corporate stocks. REITs are a pass-through vehicle for income tax purposes. That means no income taxes are owed by the REIT if they follow the tax rules and distribute at least 90% of their earnings to their shareholders. The tax favored treatment at the REIT level allows them to pay higher yields to you.
As a shareholder, your cost basis accounting is pretty much the same as for corporate common stocks for changes such as stock splits, spinoffs, etc. The main difference is that REITs tend to distribute more "return of capital" payments than common stocks do. Once a distribution rate has been established, the REITs try to avoid any decreases, even if their net funds from operations decline. Until it is absolutely necessary to reduce the distributions to shareholders, they often will maintain the same rate, but then report a portion (or all) of it as return of capital at year-end.
Your cost basis must be reduced for all the return of capital payments you received for the entire time you owned it.
The return of capital payments are reported to you on your Form 1099 each year. The REITs also usually post the information on their website, either under "Investor Relations" or "Press Releases." If you have held the stock for a long time and don't want to dig out your old Form 1099's, you can also obtain the information for prior years at the NAREIT website or use the Stock Lookup tool here at costbasis.com.
Once you have the return of capital per share for each distribution date, you can use our return of capital calculator sequentially on each distribution to roll forward your cost basis after each return of capital payment. Be sure to adjust for any stock splits that occur.
Another tax-advantaged feature of non-mortgage REITs is that the distributions are not required to be reported as UBTI (unrelated business taxable income) and no UBIT tax is owed. This means that they can be held inside IRAs and by tax-exempt organizations without incurring UBIT tax or requiring UBIT tax filings.
To be a REIT, a company must follow these tax rules: · Be taxable as a corporate entity; · Be managed by a board of directors or trustees; · Have shares that are fully transferable; · Have at least 100 shareholders; · Have no more than half of its shares held by five or fewer individuals during the last six months of each taxable year; · Invest at least three-fourths of its total assets in real estate; · Derive at least 75% of its gross income from real property rents or mortgage interest; · Have no more than one-fifth of its assets invested in taxable REIT subsidiaries; · Pay out at least 90% of its taxable income in the form of shareholder dividends.