How Do REITs Work?
As you evaluate your investments, you likely are asking a few essential questions: How close are you to reaching your financial goals? Are you prepared to fund your children's college? Are you ready to take the vacation of your dreams?
What about your retirement?
You may be able to build your portfolio without a lot of effort on your part — other than making some smart investment decisions that provide you with "passive income." Passive income is income you earn without any involvement in the activity that earns the income. It is different than ordinary income, which is the income you earn from a regular job or that is passed through to you from a pass-through entity, such as a partnership.
Many investors seeking passive income choose to invest in real estate investment trusts (REITS). REITs are companies that are funded by investors and tasked with acquiring and operating income-generating real estate properties. They are among the most common forms of passive investment, and potentially the most lucrative for investors, because the entity must guarantee to pay 90% of their taxable income as dividends to their investors to qualify as a REIT.
Approximately 145 million Americans are invested in REITs directly or through their retirement savings and other funds. Most U.S. REITs are traded on either the NYSE or the NASDAQ.
Individuals can buy shares in a REIT the same way they purchase other stock. As with other publicly traded securities, investors may purchase REIT common stock, preferred stock or debt securities. And, as with all securities, REITs aren't foolproof investments.
As you might expect, the tax rules around REITs are complicated. A broker, investment advisor or financial planner can analyze your financial goals and recommend the REIT that is right for you, whether that is owning shares in a specific REIT, a REIT mutual fund or an exchange-traded fund (ETF). With an ETF, a fund manager determines which REITs to invest in.
The advisor also will consider the tax implications of your investment. For instance, money earned from collecting rent or mortgage payments is taxed as ordinary income, whereas earnings from the sale of property at a profit is taxed as capital gains — which tends to be taxed at a more favorable rate. In addition, in some REITs, a portion of the dividend comes from a nontaxable return of capital, which can cause tax issues down the road. As with any investment, you need to do your due diligence before you commit.
For assistance determining whether a REIT might be a good investment for you, contact us today.