Real estate investment trusts, which hinge on the often solid investment of property, now offer more tax benefits in the wake of President Trump’s tax reform.

For example, REITs qualify for the new 20-percent deduction on pass-through income—a deduction capped at the greater of 50 percent of wages paid by the business or 25 percent of wages plus 2.5 percent of the property’s original purchase price.

“Lowered tax rates and allowance of the pass-through deduction have made REITs much more attractive from an income tax perspective,” said Jeff Fosselman, a CFP/CPA and senior wealth advisor at Relative Value Partners in Northbrook, Ill. 

REITs were created in 1960 “so the average person could invest in a professionally managed portfolio of real estate in a tax-favored manner,” said Matthew Bonney, a CPA and partner with Citrin Cooperman in New York. “Under prior tax law, a REIT dividend paid to an individual investor was taxed at ordinary rates, the old top bracket of 39 percent, with the tax bite making REITs less attractive than investing in securities that created qualified dividends. REITs would make up this tax disparity by paying a high yield, since the REIT doesn’t pay the entity level tax," he said.

“With passage of the new law,” he said, “a REIT shareholder gets a 20 percent deduction on REIT income—in essence, the top rate is now 29.6 percent [and] with the high yield the REIT becomes even more attractive.”

REITs also typically pass much of their earnings on to investors as dividends to investors, the latter then taxed on their individual rate. Tax reform also preserved the Sec. 1031 rule (aka “like-kind exchange”), which permits REITs to exchange an investment property holding for a similar one and defer capital gains tax on the exchange.

Do high-net-worth clients involved with real estate understand the new tax laws regarding REITs? “I doubt it,” said Brian T. Stoner, a CPA in Burbank, Calif. “Most of them will have to be educated. They don’t understand the potential volatility of these assets, mainly because of the leverage they use to generate income streams to investors. Also, mortgage REITs can be much more volatile then REITs that invest directly in real estate.”

“There’s still a lot of confusion and lack of clarity on the impact of the tax law” regarding REITs, Fosselman said. “One misconception is the tax treatment of REITs. In the past, many investors didn’t appreciate how inefficient REITs could be from a tax perspective, due to the distribution requirements and the tax treatment of income. That negative bias continues, as some high-net-worth investors just don’t consider REITs due to the tax inefficiency, even though under the new tax law they may be on a much more level playing field with other marketable investments.”

These trusts can have tax drawbacks. For instance, REITs don’t make tax sense when interest rates rise. “REITs can jump up and down a lot,” Stoner said.

“HNW clients get concerned about the interest-rate sensitivity of REITs, which can affect some sectors dependent on loans, such as mortgage REITs,” Fosselman added. “Other REIT areas are much less at risk in a rising-rate environment.”

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