REIT Distribution Rules: 90% Payout, Taxes, and Penalties

Real estate investment trust distribution rules require a REIT to pay out at least 90% of its taxable income to shareholders each year to keep its special tax status, and those payouts arrive in your account split into categories that the tax code treats very differently. The 90% floor is what lets a REIT avoid corporate income tax; the trade-off is that almost all the profit flows to you, and you owe the tax on it. What follows is what that means in practice for the money you receive.

The 90% Payout Requirement

A REIT’s dividends-paid deduction for the year must equal or exceed 90% of its “REIT taxable income.”¹ That figure is calculated after backing out two items: net capital gains from property sales and “excess noncash income.”

The capital gains exclusion means a REIT can sell a building at a profit and keep the proceeds without jeopardizing the 90% test. It simply pays corporate-level tax on whatever it retains. The excess noncash income adjustment stops a REIT from being forced to distribute cash it doesn’t have. Some income counts for tax purposes without cash attached, such as certain rental income under timing rules, cancellation-of-debt income, or original issue discount. When this noncash income exceeds 5% of taxable income for the year, the excess reduces the distribution base.¹

Nothing prevents a REIT from distributing more, and many pay out close to 100% of taxable income to eliminate the excise tax described below. The 90% figure is the floor, not the target.

How the Distributions Are Taxed

Your year-end Form 1099-DIV splits each payment into distinct boxes, and the tax treatment depends on which box the money lands in.²

Ordinary Dividends

Most of what a REIT pays you appears in Box 1a as ordinary dividends.³ These are taxed at your regular federal income tax rate, topping out at 37% for 2026.⁴ REIT ordinary dividends do not get the preferential 15% or 20% qualified-dividend rate that applies to most corporate dividends. That is the trade for the REIT not paying corporate tax first.

Higher-income investors also owe the 3.8% Net Investment Income Tax on REIT ordinary dividends. The NIIT applies once modified adjusted gross income exceeds $200,000 for single filers or $250,000 for joint filers, and those thresholds are not inflation-adjusted. Combined with the top ordinary rate, the effective federal rate on REIT ordinary dividends can reach 40.8% before the Section 199A deduction described below.

Capital Gain Dividends

When a REIT sells property at a profit, it may designate part of its distributions as capital gain dividends, reported in Box 2a.² These are taxed at long-term capital gains rates of 0%, 15%, or 20% depending on your income.

Watch for a subcategory within capital gain dividends called unrecaptured Section 1250 gain, which represents depreciation the REIT previously claimed on the sold property. That portion is taxed at a maximum rate of 25% rather than the standard capital gains rates. Your REIT or broker will identify it separately on the 1099-DIV or an accompanying statement. It is easy to overlook and can meaningfully change your tax bill when a REIT sells heavily depreciated buildings.

Return of Capital

REIT distributions frequently include a return of capital component, shown in Box 3.² This happens because depreciation deductions push the REIT’s taxable income below its cash flow. The REIT distributes cash it has but does not owe tax on, and neither do you at first.

Return of capital reduces your cost basis in the shares dollar for dollar. When you eventually sell, the lower basis produces a larger taxable gain or a smaller deductible loss. The tax is deferred and often converted from ordinary income to capital gain rates, which is usually a favorable trade.

The trap: once your basis hits zero, any further return-of-capital distributions become immediately taxable as capital gain in the year received. Long-term holders who reinvest dividends and never track basis can be caught by this. If you have owned a REIT for many years and taken substantial return of capital, verify your basis has not already been used up.

The 20% Section 199A Deduction

Section 199A lets you deduct 20% of your qualified REIT dividends from your taxable income.⁵ Originally scheduled to expire after 2025, the deduction was made permanent starting in 2026.⁴ For a 37%-bracket investor, the effective rate on qualifying REIT dividends drops to roughly 29.6% before the NIIT.

The REIT slice of the 199A deduction is simpler than the version that applies to other pass-through businesses. There is no W-2 wage limit and no qualified property limit; you take 20% off qualified REIT dividends.⁶ One holding-period rule applies: you must have held the shares for at least 46 days during the 91-day window centered on the ex-dividend date. Dividends on shares held only briefly do not qualify.

An overall cap exists. The deduction cannot exceed 20% of your total taxable income (before the deduction itself) minus net capital gains. For most investors the cap never binds, but it can matter if REIT dividends make up an unusually large share of your income.

When a Distribution Counts for Tax Purposes

A REIT usually must pay distributions during the same tax year the income is earned, but two flexibilities in the code affect which year you owe tax.

The Fourth-Quarter Rule

Dividends declared in October, November, or December and payable to shareholders of record on a specified date in one of those months are treated as both paid and received on December 31, even if the cash arrives in January.¹ You owe tax on that dividend in the declaration year, not the year you actually received it. Nearly every publicly traded REIT uses this mechanism for its December payment, so check your 1099-DIV if a January deposit seems to belong to the prior year.

The Spillover Provision

Section 858 gives REITs more room. A REIT can declare a dividend any time before its tax return deadline (including extensions) for a given year and distribute the cash within 12 months after that year closes. If the REIT makes the election on its return, the dividend counts toward the prior year’s 90% requirement.⁷

Timing on your side is different from the fourth-quarter rule. For a spillover dividend, you report the income in the year you actually receive the payment, not the year the REIT credits it against its distribution obligation.⁷ The REIT gets the prior-year deduction; you get current-year income. The mismatch is deliberate.

Penalties When a REIT Under-Distributes

Even a REIT that clears the 90% threshold can still owe a 4% excise tax if it does not distribute enough during the calendar year.⁸ The excise tax uses a stricter formula than the qualification test. The required distribution equals:

85% of ordinary income for the calendar year, plus
95% of capital gain net income for the calendar year, plus
Any shortfall carried over from prior years⁸

Capital gains are included at 95% here even though they are excluded from the 90% qualification test. So a REIT can technically satisfy the 90% requirement while still triggering excise tax on retained gains. The 4% applies to the shortfall, not to total income. Most REITs avoid it by distributing at or near 100% of both ordinary income and capital gains.

When a REIT later discovers, often through an IRS audit, that it under-reported taxable income for a prior year, the deficiency dividend procedure lets it fix the problem instead of losing REIT status. The REIT pays a corrective dividend within 90 days of the determination and files a claim within 120 days.⁹ Interest and a penalty apply, but the REIT gets the dividends-paid deduction for the retroactive distribution and preserves its tax status. For you as a shareholder, a deficiency dividend is taxable income in the year received.

A REIT that fails the distribution requirement outright, and cannot cure it, loses the REIT election and becomes a regular corporation. Income is then taxed at the entity level and again when it reaches you as a dividend. A disqualified REIT generally cannot re-elect for five taxable years, though the IRS may waive that waiting period when the failure was inadvertent, not willful, and the REIT filed timely non-fraudulent returns.¹⁰

REITs Held Inside Retirement Accounts

Most of what is above stops mattering when you hold a REIT inside a traditional IRA, 401(k), or similar tax-deferred account. Returns are not taxed as earned, and withdrawals come out as ordinary income regardless of how the REIT originally characterized the payment. You lose the Section 199A deduction, the preferential capital gain rates on capital gain dividends, and the deferral benefit of return of capital, since return of capital does nothing in an account that is not taxed currently anyway.

For investors in lower brackets who would pay 0% or 15% on long-term gains, a taxable brokerage account can produce better after-tax results on capital gain dividends than a traditional IRA. The idea that REITs “belong” in tax-advantaged accounts is clearest for investors in the highest ordinary brackets, where sheltering the ordinary-dividend portion delivers the largest benefit.

1
Office of the Law Revision Counsel. 26 USC 857 – Taxation of Real Estate Investment Trusts and Their Beneficiaries
2
Internal Revenue Service. Form 1099-DIV – Dividends and Distributions
3
Internal Revenue Service. Instructions for Form 1099-DIV
4
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
5
Office of the Law Revision Counsel. 26 US Code 199A – Qualified Business Income
6
Internal Revenue Service. Qualified Business Income Deduction
7
Office of the Law Revision Counsel. 26 USC 858 – Dividends Paid by Real Estate Investment Trust After Close of Taxable Year
8
Office of the Law Revision Counsel. 26 US Code 4981 – Excise Tax on Undistributed Income of Real Estate Investment Trusts
9
eCFR. 26 CFR 1.860-2 – Requirements for Deficiency Dividends
10
eCFR. 26 CFR 1.856-8 – Termination of Election