By Julia Santos · Founding Editor, DividendsTimes
Educational analysis, not personalized investment advice.
You bought a REIT for its generous yield, watched the quarterly (or monthly) payment hit your account, then discovered that a much larger share went to the IRS than you expected. You are not alone. Once you understand how REIT taxes work, the structure makes perfect sense, and there are straightforward ways to reduce the bite. This guide covers why REIT dividends are mostly ordinary income, the 20% qualified business income deduction that softens the blow, why the payout ratio metric you use for regular stocks can mislead you with REITs, and where to hold these positions for maximum after-tax income.
In this article
Why REIT dividends are ordinary income, not qualified
Most U.S. corporations pay taxes at the entity level and then distribute after-tax profits as dividends to shareholders. Those dividends typically qualify for the lower qualified dividend tax rate (0%, 15%, or 20% depending on your bracket). REITs operate under a different bargain with the tax code: they avoid corporate-level tax by distributing at least 90% of taxable income to shareholders. Because the REIT itself is not paying tax on that income, the IRS treats the bulk of what you receive as ordinary income, taxed at your marginal rate.
A typical REIT distribution breaks into three buckets:
- Ordinary income, the largest portion, taxed at your regular federal rate (up to 37% in the current bracket structure).
- Capital gains, a smaller slice when the REIT sells properties at a profit; taxed at long-term capital gains rates.
- Return of capital, not immediately taxed, but reduces your cost basis, which means a larger gain when you eventually sell.
The exact split varies by REIT and by year. Realty Income (O), for example, has historically distributed a mix that is mostly ordinary income with a modest return-of-capital component. You will find the breakdown on the REIT’s investor relations page or your 1099-DIV at tax time. For a deeper look at how the IRS distinguishes between qualified and ordinary dividends across all stocks, see our qualified vs. ordinary dividends tax guide.
The 20% QBI deduction (Section 199A)
Congress recognized that taxing REIT distributions entirely at ordinary rates put them at a disadvantage after the 2017 tax overhaul slashed the corporate rate. Section 199A created the qualified business income (QBI) deduction, which allows eligible taxpayers to deduct up to 20% of qualified REIT dividends before calculating their tax.
In practice, if you receive $1,000 in ordinary REIT dividends that qualify, you can deduct $200, so only $800 is subject to your marginal rate. For someone in the 24% bracket, that effectively drops the rate on REIT income from 24% to about 19.2%. The deduction is available regardless of whether you itemize.
A few things to keep in mind:
- The QBI deduction applies to ordinary REIT dividends, not to capital gains distributions or return of capital.
- It is currently scheduled to expire after 2025, though legislative proposals to extend it have been discussed. Check current law before filing.
- The deduction flows through on your 1099-DIV as “Section 199A dividends.” Most tax software picks it up automatically.
Why FFO matters more than EPS for REITs
If you run a standard EPS-based payout ratio on a REIT, you will often get an alarming number. Realty Income (O) currently pays a monthly dividend of $0.2695, which annualizes to about $3.23 per share. On a trailing EPS basis, the payout ratio can look as high as roughly 265%. By that metric, the dividend appears wildly unsustainable. It is not.
The problem is that EPS includes large depreciation charges on the REIT’s real estate. Accounting rules require buildings to be depreciated over their useful lives, which creates a non-cash expense that drags down reported earnings. But the properties are often maintaining or increasing in value, so the cash the REIT actually generates is far higher than GAAP net income suggests.
Funds from operations (FFO) adds back depreciation and amortization of real estate assets and removes gains or losses on property sales. Adjusted FFO (AFFO) goes a step further, subtracting recurring capital expenditures needed to maintain the properties. The FFO or AFFO payout ratio is the number analysts and ratings agencies use to judge whether a REIT’s dividend is safe.
When you evaluate a REIT on our tracked stock pages, keep FFO front and center. An EPS payout ratio above 100% that would be a red flag for a company like Procter & Gamble (PG) or Colgate-Palmolive (CL) is perfectly normal for a REIT. Conversely, if the FFO payout ratio starts climbing above 85% to 90% on a sustained basis, that is when you should pay closer attention to warning signs of a potential dividend cut.
Account placement: IRA vs. taxable
Because the majority of REIT income is ordinary, account placement can have a meaningful impact on your after-tax return. Here is the general framework:
- Tax-advantaged accounts (Traditional IRA, Roth IRA, 401(k)), REIT dividends grow tax-deferred or tax-free, eliminating the ordinary income drag. This is the default recommendation for most investors holding individual REITs or REIT-focused funds.
- Taxable brokerage accounts, You keep the Section 199A deduction (which you lose inside an IRA since you are not paying tax on the distributions anyway). For investors in lower brackets, the QBI deduction can make taxable holding more competitive than it first appears.
- Roth IRA, Often the best of both worlds for REITs. Distributions grow and are withdrawn tax-free in retirement. If you have limited Roth space, REITs arguably deserve priority over stocks that already pay qualified dividends at lower rates.
The decision also depends on your overall portfolio. If your taxable account is where you harvest losses or hold stocks paying qualified dividends, shifting REITs into an IRA simplifies tax season and keeps more of the yield. With long-dated Treasury yields near 19-year highs and the Fed holding rates at 3.5% to 3.75% after the July 29 meeting, the competition for income is fierce. Placing REITs in the right account helps you keep every basis point you can.
Bottom line
REIT taxes are not as painful as they look at first glance. Yes, most of the dividend is ordinary income. But Section 199A shaves up to 20% off that taxable amount, return-of-capital portions defer tax, and placing REITs in a Roth or traditional IRA can eliminate the drag entirely. Just remember to judge dividend safety by FFO or AFFO, not EPS, so you are not spooked by payout ratios that would be unsustainable for an ordinary corporation but are routine for a well-run REIT.
Frequently asked questions
Are any REIT dividends taxed at the qualified dividend rate?
A small portion can be. If a REIT earns income that was already taxed at the corporate level (for example, dividends from a taxable REIT subsidiary), that piece may be classified as a qualified dividend. Capital gains distributions also receive preferential rates. But the bulk of a typical REIT’s payout is ordinary income. Your 1099-DIV will show the exact breakdown each year.
What happens to the QBI deduction if Section 199A expires?
If Congress does not extend or replace Section 199A, the 20% deduction on qualified REIT dividends would disappear, and the full ordinary dividend would be taxed at your marginal rate. This would make tax-advantaged account placement even more important for REIT holders. Legislative discussions are ongoing, so check the current status before making long-term account decisions.
How do I find a REIT’s FFO payout ratio instead of the EPS payout ratio?
REITs report FFO and AFFO in their earnings releases and supplemental financial packages, usually filed as 8-Ks with the SEC. Many financial data sites also list FFO per share. Divide the annualized dividend by FFO per share to get the FFO payout ratio. As a general guideline, a ratio below 80% to 85% is considered comfortable for most equity REITs, while ratios consistently above 90% warrant closer scrutiny.
Educational analysis, not personalized investment advice.