Form 1120-REIT: Filing, Distributions, and Penalties

Form 1120-REIT is the annual federal income tax return filed by a corporation, trust, or association that has elected to be treated as a Real Estate Investment Trust. It reports the entity’s income, deductions, and tax liability, and it is where the REIT claims the dividends paid deduction that wipes out most entity-level tax on distributed earnings.¹ Filing this return is also how an entity makes its initial REIT election, so accuracy matters from the very first year.

What Form 1120-REIT Does

There is no separate election form for REIT status. A qualifying entity becomes a REIT by filing Form 1120-REIT as its income tax return for the first year it wants that treatment.² Because the return is not due until several months after the tax year ends, the entity has already operated a full year under the REIT rules before the return confirming its election is filed. Every qualification test must therefore be met contemporaneously, not retroactively. Two ownership tests get a grace period: the 100-shareholder rule and the rule against being closely held do not apply until the second taxable year.

Once elected, the return does three jobs each year. It calculates REIT taxable income under rules that differ meaningfully from regular corporate tax. It documents that the entity still meets the tests to remain a REIT. And it claims the dividends paid deduction that makes the whole structure work.

Who Must File and When

Form 1120-REIT is due by the 15th day of the fourth month after the tax year ends — April 15 for calendar-year filers. A REIT with a fiscal year ending June 30 must file by the 15th day of the third month, September 15.³

An automatic six-month extension is available by filing Form 7004 before the original deadline.⁴ The extension buys time to file, not time to pay. Any tax owed is still due on the original date, and interest runs from that date on anything unpaid.

Electronic filing is required for any REIT that files 10 or more returns of any type during the calendar year, counting income tax, employment tax, excise tax, and information returns together.² Because most REITs issue numerous 1099-DIV forms to shareholders, nearly every REIT hits this threshold. A waiver is possible for entities that qualify for an exception.

A REIT expecting total tax liability of $500 or more for the year must make quarterly estimated tax payments by electronic funds transfer.³ Installments fall on the 15th day of the fourth, sixth, ninth, and twelfth months of the tax year. For a calendar-year REIT, those dates are April 15, June 15, September 15, and December 15. Most REITs distribute enough income to deduct their way out of ordinary tax, so estimated payments usually cover retained income, prohibited transaction tax, or foreclosure property income.

Qualification Tests the Return Must Confirm

REIT status is not permanent. Each year the return must show the entity still meets organizational, ownership, asset, income, and distribution tests. Failing any of them can cost the REIT its status entirely and subject all of its income to standard corporate tax rates.

Organizational and Ownership

The entity must be managed by a board of directors or trustees. Starting in year two, it must have at least 100 shareholders, and it cannot be closely held: five or fewer individuals cannot own more than 50% of the stock during the last half of the tax year.⁵

Assets

At the close of each quarter, at least 75% of total asset value must consist of real estate assets, cash, or government securities.⁶ The remaining assets face diversification limits: no more than 5% of total asset value in securities of any one issuer; no more than 10% of the voting power or value of any one issuer’s outstanding securities; and no more than 25% of total assets in securities of taxable REIT subsidiaries. These are measured quarterly, so drift mid-quarter can be corrected before the next test date.

Income

Two gross income tests apply annually. At least 75% of gross income must come from real estate sources such as rents from real property, mortgage interest, and gains from selling real property. At least 95% must come from those same sources plus other passive income like dividends, interest, and securities gains.⁶ A REIT that provides tenant services beyond what a normal landlord offers risks failing these tests by generating too much active business income.

Distributions

The REIT must distribute at least 90% of REIT taxable income (calculated without the dividends paid deduction and excluding net capital gains) to shareholders each year.⁵ This is the test that makes the REIT act like a pass-through: entity-level tax disappears on distributed income, and shareholders pick it up on their own returns.

How REIT Taxable Income Differs

REIT taxable income starts with gross income and subtracts ordinary business expenses like property management, depreciation, and overhead. Several REIT-specific adjustments then change the picture.

Prohibited Transactions

Income from prohibited transactions is taxed at 100%. A prohibited transaction is essentially a sale of property held primarily for sale to customers in the ordinary course of business — the kind of dealer-style flipping the REIT rules push against.⁵ Safe harbors exist based on holding period and sales volume, but every property disposition needs a close look.

Foreclosure Property

Net income from foreclosure property is taxed separately at the highest corporate rate under Section 11(b), currently 21%.⁵ This income is excluded from REIT taxable income for the 90% distribution test, so it does not inflate the required distribution.

Capital Gains

Net capital gains are included in REIT taxable income but can be either distributed to shareholders as capital gain dividends or retained with the REIT paying corporate tax on them. When gains are retained, shareholders still report their share and receive a credit for the tax the REIT paid, with notification via Form 2439.

Disallowed Deductions

REITs cannot claim the dividends received deduction that C corporations use on dividends from other domestic corporations. Because REITs already deduct the dividends they pay out, allowing a deduction on dividends coming in would create a double benefit.

Section 163(j) Election

The business interest expense limitation caps deductible interest at 30% of adjusted taxable income for most businesses. A REIT can make an irrevocable election as an electing real property trade or business to sidestep the cap, but must then use the alternative depreciation system (ADS) for real property instead of MACRS.³ Whether the unlimited interest deduction is worth slower depreciation depends on the REIT’s leverage and property mix. Schedule K asks directly whether this election is in effect.

The Dividends Paid Deduction and Timing Fixes

The dividends paid deduction is what collapses REIT-level tax on distributed income. Only distributions that qualify as dividends — paid from current or accumulated earnings and profits — count.

Spillover Election

REITs often don’t know their exact taxable income until well after year-end. The spillover election under Section 858 lets a REIT treat certain dividends declared after year-end as if paid during the prior tax year. The dividend must be declared before the return’s filing deadline (including extensions) and distributed within 12 months after the close of the taxable year, and the distribution must occur before the first regular dividend paid after the declaration.⁷ The exact dollar amount must be specified on Form 1120-REIT. Because the REIT reduces prior-year income with a dividend shareholders won’t report until later, the IRS charges interest on the resulting timing benefit.

A separate rule under Section 857(b)(9) treats dividends declared in October, November, or December to shareholders of record during those months as paid on December 31, as long as the REIT actually distributes them during January of the following year.

Deficiency Dividends

If the IRS later determines that taxable income for a prior year was higher than reported, the REIT could retroactively fail the 90% distribution test. The deficiency dividend procedure under Section 860 lets the REIT distribute the additional amount after the determination and claim a deduction for the earlier year, preserving REIT status.⁸ Interest and any applicable penalties on the original underpayment still apply. This is a last resort, available only after an IRS determination, Tax Court decision, or closing agreement.

Schedules, Statements, and Shareholder Reporting

Schedule K

Schedule K on Form 1120-REIT is a compliance questionnaire titled “Other Information,” not a shareholder allocation schedule of the kind used on partnership or S-corporation returns. It asks whether any foreign person owns 25% or more of the stock, whether the Section 163(j) election is in effect, whether the entity qualifies as a Qualified Opportunity Fund, and similar entity-level questions.³ Every applicable line must be answered. Shareholders receive their income information on Form 1099-DIV, not a Schedule K-1.

Schedule M-1 or M-3

Every REIT must reconcile book income to taxable income. REITs with total assets of $10 million or more use Schedule M-3, which requires line-by-line detail. Smaller REITs use Schedule M-1.⁹ Common reconciling items include depreciation method differences, capitalized lease adjustments, and revenue recognition timing.

Income and Asset Test Statements

Supporting statements must demonstrate compliance with the 75% and 95% income tests and the quarterly asset tests, categorizing income sources and detailing asset composition at each quarter-end. Any elections, including the Section 858 spillover, are documented in attached statements specifying dollar amounts.

Form 1099-DIV

The REIT must file Form 1099-DIV for each shareholder who received $10 or more in distributions during the year, designating amounts as ordinary dividends, capital gain distributions, or other categories.¹⁰ These designations correspond directly to the dividends paid deduction claimed on the return, and misclassification invites IRS scrutiny.

Annual Shareholder Demand Letters

Because REIT qualification depends on ownership not being too concentrated, the entity must verify who owns its shares each year. Within 30 days after the close of the tax year — January 30 for calendar-year REITs — the REIT must send written demand letters to certain shareholders of record requesting ownership information.¹¹ The threshold depends on how many shareholders the REIT has:

2,000 or more shareholders: each holder of 5% or more of the stock.
201 to 1,999 shareholders: each holder of 1% or more.
200 or fewer shareholders: each holder of 0.5% or more.

The penalty for failing to comply is $25,000 per taxable year, rising to $50,000 for intentional disregard. If the IRS directs corrective steps and the REIT still fails to act, an additional penalty of the same amount applies. No penalty applies if the failure is due to reasonable cause and not willful neglect.⁵ The REIT must also keep a list of shareholders who refuse to respond. A complete failure to maintain ownership records can result in the entity being taxed as an ordinary corporation.

Penalties for Getting It Wrong

Late Filing

Filing after the deadline (including extensions) triggers a penalty of 5% of the unpaid tax for each month or partial month late, capped at 25%.¹² For returns more than 60 days late, the minimum penalty for returns required to be filed in 2026 is the lesser of the tax due or $525.³

Late Payment

Failing to pay the tax shown on the return by the original due date adds a separate penalty of 0.5% of the unpaid tax per month, also capped at 25%.¹³ When both apply in the same month, the filing penalty is reduced by the payment penalty amount, so the combined rate for that month is 5% rather than 5.5%.

Accuracy-Related Penalty

A 20% accuracy-related penalty applies to underpayments caused by negligence or a substantial understatement of income. For corporations other than S corporations, a substantial understatement exists when it exceeds the lesser of 10% of the correct tax (or $10,000, whichever is greater) or $10 million.¹⁴ Given the complexity of REIT income and asset tests, this is a realistic risk.

4% Excise Tax on Underdistributions

Even a REIT that clears the 90% distribution floor can owe a 4% excise tax under Section 4981 if it distributes less than a higher threshold set by that provision.¹⁵ The excise-tax threshold sits above the 90% qualification floor, which is why many REITs distribute 95% to 100% of taxable income to avoid the tax.

Loss of REIT Status

The most severe outcome is losing REIT status entirely. Missing an income, asset, ownership, or distribution test can strip the entity of REIT treatment and subject all of its income to standard corporate tax rates, layered on top of shareholder-level tax when the income is eventually distributed.

State Tax Is a Separate Question

Form 1120-REIT is a federal return. State treatment of REITs varies widely. Some states follow the federal approach and allow a dividends paid deduction; others impose franchise tax, gross receipts tax, or other entity-level taxes that do not conform to the federal framework. A REIT operating across multiple states may owe entity-level tax in some jurisdictions despite owing little or nothing federally. State filings, deadlines, and forms should be evaluated separately in every state where the REIT owns property or conducts business.

1
Internal Revenue Service. About Form 1120-REIT
2
Internal Revenue Service. Instructions for Form 1120-REIT
3
Internal Revenue Service. Instructions for Form 1120-REIT
4
Internal Revenue Service. Instructions for Form 7004
5
Office of the Law Revision Counsel. 26 U.S. Code 857 – Taxation of Real Estate Investment Trusts and Their Beneficiaries
6
Office of the Law Revision Counsel. 26 U.S. Code 856 – Definition of Real Estate Investment Trust
7
Office of the Law Revision Counsel. 26 U.S. Code 858 – Dividends Paid by Real Estate Investment Trust After Close of Taxable Year
8
Office of the Law Revision Counsel. 26 U.S. Code 860 – Deduction for Deficiency Dividends
9
Internal Revenue Service. Instructions for Schedule M-3 (Form 1120)
10
Internal Revenue Service. Instructions for Form 1099-DIV
11
eCFR. 26 CFR 1.857-8 – Records to Be Kept by a Real Estate Investment Trust
12
Internal Revenue Service. Failure to File Penalty
13
Internal Revenue Service. Failure to Pay Penalty
14
Internal Revenue Service. Accuracy-Related Penalty
15
Office of the Law Revision Counsel. 26 U.S. Code 4981 – Excise Tax on Undistributed Income of Real Estate Investment Trusts