Section 857 REIT taxation works as a conduit: a real estate investment trust that distributes at least 90% of its taxable income to shareholders deducts those dividends from its own income and pays little or no corporate-level tax, while the shareholders pay tax on what they receive. The trade-off is a set of strict rules about what counts as taxable income, when the distributions must be made, and how each dollar is characterized when it reaches the investor.
How REIT Taxable Income Is Calculated
The number that drives everything under Section 857 is Real Estate Investment Trust Taxable Income (REITTI). It starts with the REIT’s overall taxable income and then strips out items that follow their own tax path.
Corporate-level deductions from Part VIII of Subchapter B are disallowed, most importantly the dividends received deduction that ordinary corporations use to exclude a portion of dividends from other domestic corporations. The one survivor is the deduction for organizational expenditures under Section 248.1Office of the Law Revision Counsel. 26 USC 857 – Taxation of Real Estate Investment Trusts and Their Beneficiaries
Net capital gains are also excluded from REITTI because they run on a parallel track. A REIT can either distribute long-term capital gains as Capital Gain Dividends or retain them, pay tax at the entity level, and pass the retained gain through to shareholders as undistributed capital gains. Pulling them out of the base prevents double-counting.
Two more streams sit outside REITTI because they carry their own entity-level taxes. Income from prohibited transactions — sales of property the REIT held primarily for sale to customers, essentially dealer activity — is excluded from REITTI and hit instead with a separate 100% tax on the net gain. Losses from prohibited transactions get no deduction against REITTI either; an amount equal to a net prohibited-transaction loss is added back into the calculation. Net income from foreclosure property is similarly excluded because the REIT pays a separate tax on it at the highest corporate rate under Section 11(b), currently 21%.2Office of the Law Revision Counsel. 26 U.S. Code 857 – Taxation of Real Estate Investment Trusts and Their Beneficiaries
A third entity-level tax applies under Section 857(b)(7) to redetermined rents, redetermined deductions, excess interest, and redetermined service income arising from transactions between a REIT and its Taxable REIT Subsidiary. The tax is imposed at 100% and is designed to stop REITs from shifting income to, or inflating deductions through, a TRS.2Office of the Law Revision Counsel. 26 U.S. Code 857 – Taxation of Real Estate Investment Trusts and Their Beneficiaries Taxes paid under any of these provisions reduce REITTI, so the distribution requirement is measured against income after entity-level taxes have already been paid.
Finally, any prior-year net operating loss carried through the current year to a future year under Section 172 is excluded from the current year’s taxable income.3Office of the Law Revision Counsel. 26 USC 172 – Net Operating Loss Deduction That keeps the 90% distribution requirement tied to income the REIT actually earned in the current year rather than income absorbed by carryovers.
The 90% Distribution Requirement and the Dividends Paid Deduction
The dividends paid deduction is the mechanism that empties out corporate-level income. After computing REITTI, the REIT deducts dividends paid to shareholders during the year. Distribute enough, and the deduction wipes out most or all of what would otherwise be taxable.
The floor is 90%. A REIT must distribute at least 90% of REITTI, computed before the dividends paid deduction and excluding net capital gains.1Office of the Law Revision Counsel. 26 USC 857 – Taxation of Real Estate Investment Trusts and Their Beneficiaries Fall below that, and the REIT loses its conduit status for the year.
Because a REIT rarely knows its exact income on the last day of the fiscal year, the Code builds in three timing tools that let a REIT hit the 90% mark after the fact.
Spillover Dividends
Under Section 858, a dividend the REIT declares before the due date for its tax return (including extensions) and pays within 12 months after the close of the taxable year can be treated as paid during the preceding year for purposes of the dividends paid deduction.4Office of the Law Revision Counsel. 26 USC 858 – Dividends Paid by Real Estate Investment Trust After Close of Taxable Year The REIT elects the treatment on its return and specifies the amount. Shareholders include the spillover in income for the year they actually receive it.
Consent Dividends
Section 565 lets a REIT satisfy part of the distribution requirement without moving cash. Each shareholder holding “consent stock” on the last day of the taxable year files a consent with the REIT’s return agreeing to treat a specified amount as if it were a dividend received and immediately reinvested.5Office of the Law Revision Counsel. 26 U.S. Code 565 – Consent Dividends No money changes hands, but the amount counts toward the DPD. For foreign shareholders, the consent must be accompanied by payment equal to the withholding tax that would have applied to a cash dividend. Consent dividends are most useful when a REIT is cash-constrained but needs to clear the 90% floor.
Deficiency Dividends
If the IRS later adjusts the REIT’s taxable income upward and creates a distribution shortfall, Section 860 offers a retroactive fix. The REIT distributes property to shareholders within 90 days of the determination and files Form 976 (Claim for Deficiency Dividends Deduction) within 120 days of the determination.6Office of the Law Revision Counsel. 26 USC 860 – Deduction for Deficiency Dividends That preserves conduit status despite the original underdistribution. The procedure is unavailable when the shortfall resulted from fraud or willful failure to file a timely return.
The 4% Excise Tax Under Section 4981
Meeting the 90% floor keeps the REIT’s conduit status alive, but a separate calendar-year test penalizes REITs that distribute too slowly. Section 4981 imposes a 4% non-deductible excise tax on any shortfall between required distributions and actual distributions.
The required distribution equals 85% of the REIT’s ordinary income plus 95% of its capital gain net income for the calendar year.7Office of the Law Revision Counsel. 26 USC 4981 – Excise Tax on Undistributed Income of Real Estate Investment Trusts The “distributed amount” includes dividends paid during the calendar year plus any income on which the REIT already paid corporate tax under Section 857. So a REIT can retain up to 15% of ordinary income and 5% of capital gains without triggering the excise tax, but any prior-year shortfall is added into the current year’s requirement.
REITs report and pay the excise tax on Form 8612, due by March 15 of the following calendar year.8Internal Revenue Service. Instructions for Form 8612 An automatic six-month extension is available for filing the return, but it does not delay the tax payment itself.9eCFR. 26 CFR Part 55 – Excise Tax on Real Estate Investment Trusts and Regulated Investment Companies
How Shareholders Are Taxed on REIT Dividends
Because the REIT itself pays little tax, the shareholder side does the work. Investors receive Form 1099-DIV each year, and the character of the income flows through by category rather than being flattened into a single “dividend” bucket.
Ordinary Dividends and the Section 199A Deduction
Most REIT distributions are taxed as ordinary income at the shareholder’s marginal rate, which in 2026 can reach 37%.10Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Unlike dividends from regular corporations, REIT ordinary dividends generally do not qualify for the reduced rates that apply to Qualified Dividend Income.
Section 199A provides a meaningful offset. Individual taxpayers can deduct up to 20% of qualified REIT dividends, which effectively caps the top rate on those dividends at roughly 29.6%.11Internal Revenue Service. Qualified Business Income Deduction The One Big Beautiful Bill Act made the deduction permanent starting in 2026 and widened the phase-in ranges to $75,000 for single filers and $150,000 for joint filers, letting more taxpayers claim at least a partial deduction before income-based limitations fully apply.
Capital Gain Dividends
When a REIT sells an asset at a long-term capital gain, it can designate part of its distribution as a Capital Gain Dividend. The gain keeps its long-term character and qualifies for preferential capital gains rates in the shareholder’s hands. The REIT must notify shareholders of the designated amount in a written notice mailed within 60 days after the close of the taxable year.12Office of the Law Revision Counsel. 26 USC Subtitle A, Chapter 1, Subchapter M – Regulated Investment Companies and Real Estate Investment Trusts
Unrecaptured Section 1250 Gain
REITs that own depreciable real property frequently generate unrecaptured Section 1250 gain on sale — the portion of gain attributable to previously claimed depreciation. When the REIT passes this gain through, it is taxed at a maximum rate of 25%, which sits between the ordinary income rate and the lower long-term capital gains rate. It is easy to miss on a 1099-DIV and carries a meaningfully higher rate than other capital gains.
Return of Capital
Sometimes a REIT distributes more than its current and accumulated earnings and profits. The excess is treated as a return of capital, which is not taxed when received. Instead, it reduces the shareholder’s adjusted basis in the shares. Once basis reaches zero, further return-of-capital distributions are taxed as capital gains. When the shareholder eventually sells, the lower basis produces a larger taxable gain, so return of capital is a deferral rather than an exemption.
Foreign Investor Withholding
Non-U.S. shareholders face a default 30% withholding tax on ordinary REIT dividends, subject to reduction under an applicable treaty. Capital gain dividends are more layered. For publicly listed REITs, a foreign shareholder who owns 10% or less of the REIT’s stock is generally subject to the 30% (or treaty) withholding rate rather than full FIRPTA treatment. Shareholders above that threshold, or shareholders in a nonlisted REIT, face FIRPTA taxation and higher withholding. The rules turn on whether the REIT is listed, whether it is domestically controlled, and the size of the stake, so foreign investors should confirm their specific situation before assuming a treaty rate applies.
What Happens If a REIT Loses Its Status
A REIT that fails its income tests, asset tests, or the 90% distribution minimum is taxed as an ordinary C corporation for that year. The consequences compound: the entity loses the dividends paid deduction, so all income is taxed at the 21% corporate rate, and distributions are then taxed again at the shareholder level. The double layer eliminates the entire economic benefit of the conduit structure.
Getting back in is not quick. A REIT that revokes or loses its election generally cannot re-elect for five years unless the IRS grants a waiver. That is why the spillover, consent, and deficiency dividend tools matter so much in practice. They exist precisely so that a timing gap or a computational error doesn’t cost a REIT its status. A REIT that ignores them and simply underdistributes has no easy path back.