REITs, Explained: How Real Estate Investment Trusts Turn Rent Into Dividends

Your brokerage account can pay you rent from apartment buildings, warehouses, and cell towers you have never visited — without a single midnight plumbing call. That is the promise of a real estate investment trust, and the catch is not hidden in fine print: it is written into the tax code itself. A REIT must hand nearly all of its taxable income to shareholders every year, which is exactly why its yield runs far above the average stock — and exactly why its dividends are taxed differently from almost everything else in your portfolio.

Here is how the structure works, where the 90% rule comes from, and what to know before you buy.

What a REIT Actually Is​

A real estate investment trust is a company that owns, operates, or finances income-producing real estate and sells shares of itself to investors. Instead of buying a rental property, you buy a slice of a portfolio that might hold hundreds of properties: apartment complexes, office towers, shopping centers, warehouses, data centers, cell towers, hospitals, timberland, even billboards.

Congress created the structure in 1960 so small investors could earn real-estate income without buying whole buildings. The trade works like this:

• You get liquid, diversified exposure to commercial real estate plus a dividend stream funded mostly by rent.
• The REIT gets access to public capital markets.
• The IRS gets its cut once, at the shareholder level, instead of twice.

That last point is the whole engine. A regular corporation pays corporate income tax on its profits, and then shareholders pay tax again on dividends. A REIT that follows the qualification rules skips the corporate-level tax almost entirely — but only if it passes nearly all of its taxable income straight through to you.

The 90% Payout Rule: Why REIT Yields Run High​

To keep its special tax status, a REIT must distribute at least 90% of its taxable income to shareholders each year. This is not a generous management policy the board can suspend when times get tough. It is a legal condition of being a REIT at all, enforced under Section 857 of the Internal Revenue Code.

That single rule explains the two most important facts about REIT investing:

1. Yields run well above the broad market average. When a company is legally required to pay out almost everything it earns, the dividend yield is structural, not cyclical. Publicly traded equity REITs have averaged yields in the high 3% to mid-4% range over recent decades, against roughly 1.5% for the S&P 500.
2. REITs retain almost no capital to reinvest. A technology company can plow profits into growth; a REIT must keep paying them out, then raise fresh debt or issue new shares whenever it wants to expand. That makes REITs sensitive to interest rates and credit conditions in a way ordinary stocks are not.

The 90% rule is only the most famous of several qualification tests. A company must also:

• Invest at least 75% of its assets in real estate, cash, or government securities.
• Derive at least 75% of its gross income from rents, mortgage interest, or property sales — and at least 95% from those sources plus passive income like dividends and interest.
• Have at least 100 shareholders after its first year.
• Satisfy the "5/50 rule": five or fewer individuals may not own more than 50% of its shares.

Fail these tests and the company loses REIT status — and with it, the pass-through tax treatment. The structure is strict by design: Congress wanted rent flowing to small shareholders, not a tax shelter for a handful of owners.

Equity vs. Mortgage REITs: Two Businesses Sharing One Acronym​

Not every REIT collects rent. The label covers three distinct business models, and confusing them is one of the costliest beginner mistakes.

Equity REITs: Landlords at Scale​

Equity REITs own and operate physical property. Their income is rent minus operating costs, and their value grows when properties appreciate or rents rise. This is the largest and most familiar category — roughly nine in ten exchange-listed REITs are equity REITs.

Equity REITs usually specialize by property type: residential apartments, industrial warehouses, office buildings, retail centers, health care facilities, self-storage, data centers, cell towers, or timberland. Specialization matters because each sector runs on its own cycle. Warehouse rents can surge on e-commerce demand while office rents sag under remote work — same "REIT" label, opposite years.

Mortgage REITs: Lenders, Not Landlords​

Mortgage REITs (mREITs) generally own no buildings at all. They originate or buy mortgages and mortgage-backed securities, earn interest on that debt, and profit from the spread between their borrowing cost and the interest they collect.

That spread business makes mREITs behave nothing like equity REITs:

• Their dividends often look spectacular — double-digit yields are common — because they run heavy leverage.
• They are brutally sensitive to interest rates. When short-term borrowing costs rise faster than the yields on the mortgages they hold, the spread compresses and dividends get cut.
• They own financial instruments, not appreciating land, so there is no property-value growth cushioning a bad year.

Treat an mREIT as a leveraged bond fund wearing a REIT costume, and size the position accordingly.

Hybrid REITs: A Foot in Both Camps​

Hybrid REITs combine both strategies, holding physical property alongside mortgages or mortgage-backed securities. The mix is meant to balance rental income and appreciation potential against interest income. Hybrids are the smallest category, and they inherit risks from both sides — property cycles plus interest-rate exposure — with financial statements that take more work to read.

The practical rule: unless you specifically want leveraged interest-rate exposure, start with publicly traded equity REITs. Their income comes from rent checks, which are far easier to understand — and to trust — than a leveraged spread book.

Traded vs. Non-Traded Shares: Same Name, Different Planet​

How you buy a REIT matters as much as which kind you buy. The SEC draws a sharp line between the two markets, and its investor bulletin on REITs is blunt about the gap.

Publicly Traded REITs​

These list on national stock exchanges and trade like any stock, with continuous pricing, same-day liquidity (settling next business day under T+1), regular SEC filings, and ordinary brokerage commissions. You can research them, compare them, and sell them on any trading day. For most investors, this is the only REIT market worth entering.

Non-Traded REITs​

Non-traded REITs do not list on any exchange. There is no market price — valuations come from periodic appraisals governed by the offering documents — and getting your money out typically means a redemption program capped at a small percentage of shares per quarter, often suspended exactly when you most want to sell.

The fee load is the other shock. Non-traded REITs commonly charge upfront offering costs and commissions totaling 10% to 15% of your investment before a single dollar earns anything, plus ongoing management fees. Private REITs, which are not even registered with the SEC and are limited to accredited investors, offer less transparency still.

A 6% distribution yield stops looking generous once you learn that 12 cents of every dollar you invested went to fees on day one. If anyone pitches you a non-traded REIT, read the offering documents' fee table and redemption terms before you read anything else.

How REIT Dividends Are Taxed (and the 20% Deduction That Softens the Bill)​

Here is the trade-off for those high yields: most REIT dividends are taxed as ordinary income, not at the lower qualified-dividend rates that apply to most corporate stock dividends. A REIT distribution can arrive in up to three tax flavors, and your Form 1099-DIV reports each in its own box:

• Ordinary dividends (Box 1a). The bulk of most REIT payouts — rent passed through to you, taxed at your marginal income-tax rate.
• Capital gain distributions (Box 2a). Paid when the REIT sells properties at a profit. Taxed at capital-gain rates.
• Return of capital (Box 3). Not income at all this year — it is the REIT handing part of your own investment back, typically funded by depreciation. It reduces your cost basis instead, which raises your eventual capital gain (or shrinks your loss) when you sell.

The Section 199A Pass-Through Deduction​

Congress softened the ordinary-income treatment with a dedicated break: you may generally deduct 20% of your qualified REIT dividends from your taxable income. Receive $10,000 in qualifying REIT dividends and you deduct $2,000, paying tax on only $8,000 — a $480 saving for someone in the 24% bracket.

Three details make this deduction unusually friendly:

• No wage or capital limits. The 20% deduction for other pass-through business income phases down for higher earners unless the business pays enough W-2 wages or holds enough capital. The REIT-dividend component has no such test.
• No itemizing required. You claim it whether you itemize or take the standard deduction.
• Funds pass it through. Mutual funds and ETFs that receive REIT dividends can pass the 199A character through to you, so index-fund investors get the break on the REIT slice of their holdings too.

Only the ordinary-income portion qualifies — capital gain distributions and any qualified-dividend slice are excluded — and the total 199A deduction cannot exceed 20% of your taxable income minus net capital gains. Confirm the deduction's status for the tax year you are filing, since the provision carries a statutory sunset date that Congress periodically revisits.

Because so much REIT income arrives as ordinary dividends, many investors hold REITs inside tax-advantaged accounts like IRAs, where the yearly tax character stops mattering. That is often sensible — but run the numbers first, since sheltered accounts also waste the 199A deduction and the return-of-capital basis mechanics.

Tracking REIT Income in Your Own Books​

REIT distributions are a small bookkeeping project of their own: one cash payment that splits into ordinary income, capital gains, and basis adjustments. Plain-text accounting handles this cleanly because every split is explicit. When your $500 quarterly distribution arrives — say $380 ordinary dividends, $70 capital gain distribution, and $50 return of capital — record each leg:

2026-10-15 * "Vanguard" "VNQ quarterly distribution"
  Assets:Brokerage:Cash                         500.00 USD
  Income:Dividends:REIT:Ordinary                -380.00 USD
  Income:Dividends:REIT:Capital-Gain-Dist        -70.00 USD
  Assets:Brokerage:VNQ:Cost-Basis                -50.00 USD

The return-of-capital leg is the one investors most often mishandle: it is not income, so booking it as a dividend overstates this year's earnings and leaves your cost basis wrong when you sell. With the basis tracked as its own account, your eventual sale entry balances against the true adjusted cost, and a BQL query over Income:Dividends:REIT:* gives you the exact ordinary-vs-gain split at tax time. If you prefer dashboards to queries, the same accounts render as income breakdowns in Fava.

Mistakes That Cost REIT Investors Real Money​

• Chasing mortgage-REIT yields as if they were rent. A 12% mREIT yield is compensation for leverage and rate risk, not a bargain version of a 4% equity-REIT yield. Compare each against its own category's history, and check the dividend's trend — serial cuts are the mREIT tell.
• Treating every distribution as a qualified dividend. Budget for ordinary-income rates on the bulk of the payout, then treat the 199A deduction as relief, not as the plan.
• Ignoring the fee load on non-traded shares. Any yield comparison that skips 10–15% upfront costs and redemption gates is not a comparison.
• Forgetting return of capital at sale time. Years of Box 3 distributions quietly lower your basis. Sell without adjusting and you will overpay capital-gains tax — or underreport it.
• Assuming the payout can never fall. The 90% rule sets a floor under the payout ratio, not under the dividend. If rental income drops, 90% of a smaller number is a smaller check.

Your Next Step: Read One 1099-DIV​

Before you buy your first REIT share, pull up last year's Form 1099-DIV from any dividend-paying holding you already own and find Boxes 1a, 2a, and 3. That one page is the entire tax story above in miniature: ordinary income you will owe rates on, gains with their own treatment, and basis adjustments you must track. If you can sort a distribution into those three buckets — and you now know how the 20% deduction lightens the first — you understand REIT taxation better than most people collecting the dividends.