While there are many tax and investment benefits to investing directly in real estate, not everyone wants to be a hands-on landlord. For those who buy a substantial amount of real estate, it’s often cost effective to hire a property manager to delegate such management tasks to. For everyone else, the most appealing option is simply to become a “pooled” real estate investor with others, through a Real Estate Investment Trust (REIT), which allows some of the pass-through tax benefits of real estate investing, but with better management economies of scale and more diversification than what most investors can feasibly access with limited dollar amounts to invest.
Under the Tax Cuts and Jobs Act of 2017, though, REITs have been afforded a new tax preference: the IRC Section 199A deduction for “pass-through” businesses, that allows for a 20% deduction of any qualified REIT dividends against that very income, resulting in an effective 20% reduction in the tax rate on REITs (where the top 37% tax rate becomes “just” 29.6% instead).
Notably, the new Qualified Business Income (QBI) deduction under Section 199A is available for direct investments in real estate as well. However, direct real estate investments only qualify for the deduction if the amount of real estate investment activity amounts to a real estate “business” (where purely passive real estate investment income may not count), and is further limited for certain high-income individuals due to wage-and-depreciable-property tests that apply to married couples with taxable income above $315,000, and all other filers with taxable income about $157,500. By contrast, qualified REIT dividends simply obtain the 20% Section 199A deduction, implicitly counting as a real estate “business” (by virtue of a REIT’s size and scale), and without any high-income limitations on the deduction!
Of course, in the end, an investment in a REIT should be evaluated by its overall investment merits, and not just its tax treatment alone. Nonetheless, for otherwise equal real estate investments, going forward, REITs will be substantially easier to qualify for the full Section 199A deduction with fewer limitations for high-income individuals, and a tax benefit sizable enough that REITs almost (but not quite) enjoy tax benefits similar to the preferences for long-term capital gains and qualified dividends. Which means at a minimum, the relative improvement of tax treatment for REITs will mean they deserve a “fresh look” from an investment perspective… along with a re-evaluation of where they should be held from an asset location perspective (given that REITs held in a tax-preferenced retirement account will lose out on the new Section 199A deduction!).
source https://www.kitces.com/blog/reit-real-estate-investments-section-199a-qbi-deduction/
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