Author Topic: Taxation of real estate index funds  (Read 2611 times)

Mighty-Dollar

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Taxation of real estate index funds
« on: May 05, 2015, 02:53:29 PM »
Are real estate index funds taxed as ordinary income just an non-traded REIT's are?

forummm

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Re: Taxation of real estate index funds
« Reply #1 on: May 05, 2015, 04:57:05 PM »
REIT index funds capital gains (when you buy/sell) and dividends are taxed the same as any other index fund.

https://personal.vanguard.com/us/funds/snapshot?FundId=5123&FundIntExt=INT#tab=4
« Last Edit: May 06, 2015, 08:58:06 AM by forummm »

seattlecyclone

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Re: Taxation of real estate index funds
« Reply #2 on: May 05, 2015, 05:04:56 PM »
Actually per this list, only 3.42% of the dividends paid by the REIT index fund count as qualified dividends. The remaining 96.58% is non-qualified and thus taxed at your normal rate.

forummm

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Re: Taxation of real estate index funds
« Reply #3 on: May 05, 2015, 05:53:44 PM »
International index funds also often have a portion of unqualified dividends.

seattlecyclone

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Re: Taxation of real estate index funds
« Reply #4 on: May 05, 2015, 06:01:11 PM »
Indeed. Dividends from countries that we don't have a tax treaty with don't meet the "qualified dividend" requirements either.

The bottom line is that mutual funds don't magically reduce the taxes on dividends. If a security pays a non-qualified dividend, a mutual fund holding that security and passing on the dividends will also pay a non-qualified dividend.

forummm

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Re: Taxation of real estate index funds
« Reply #5 on: May 05, 2015, 07:06:06 PM »
Excellent points, Cyclone.

Another consideration OP is that REITs have a higher yield than most stocks because they are required to distribute 90% of their taxable income as dividends. So they are somewhat less tax efficient than the average stock or broad-based mutual fund.

Some more info: http://www.sec.gov/answers/reits.htm

Mighty-Dollar

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Re: Taxation of real estate index funds
« Reply #6 on: May 06, 2015, 12:10:54 AM »
REIT index funds capital gains (when you buy/sell) and dividends are taxed the same as any other index fund. But they also have returns of capital that are taxed too.

https://personal.vanguard.com/us/funds/snapshot?FundId=5123&FundIntExt=INT#tab=4
You say return of capital is taxed, but just at the (lower) capital gains tax rate?  Is that what you're saying? Sounds like a raw deal if you're in a higher tax bracket. I know that capital gains taxes don't kick in until about $47,000 on income for the year.

So to summarize both non-traded REITS and REIT index funds are taxed the same but index funds typically have lower dividend rates and therefore they probably work out as a tax savings? Is that what you all are saying?

Cathy

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Re: Taxation of real estate index funds
« Reply #7 on: May 06, 2015, 12:49:04 AM »
A return of capital is not subject to income tax because it is not income. It is literally just giving your own money back to you, hence the name "return of capital". However, when you receive a return of capital, your cost basis in the security is reduced by the amount of the return of capital, and the result of that is that when you eventually sell the security, the capital gain will be higher than it otherwise would have been.

Here's the legal basis for the above claims.

26 USC 301(c)(2) says that a distribution from a corporation to its shareholders that is not made from the corporation's earnings and profits is not included in the gross income of the shareholder, subject to the exception mentioned later in this paragraph. However, 26 USC 316(a) says essentially that a corporation must distribute all its earnings and profits before it can distribute capital. 26 USC 301(c)(2) says that the taxpayer's basis in the security is reduced by the amount of the return of capital. 26 USC 301(c)(3) says that if the return of capital is greater than the taxpayer's basis in the security, then the excess is treated as a capital gain and is included in gross income, unless the increase in value accrued before March 1, 1913 (in which case it is exempt from income tax).

It still remains to explain why the above scheme applies to REITs. 26 USC 856 says that a REIT is a corporation, trust, or association satisfying a number of requirements. If the REIT is a corporation, then the above discussion concludes the matter. But what if it is a trust or association? In that case, 26 CFR 301.7701-2(b)(2) says that the term "corporation" for federal tax purposes includes an association determined under 26 CFR 301.7701-3. Meanwhile, 26 CFR 301.7701-3(c)(v)(B) says a REIT that, but for 26 CFR 301.7701-2(b)(2), would not be a corporation, is deemed to be an association. In turn, 26 CFR 301.7701-2(b)(2) thus makes a REIT a corporation for federal tax purposes, so the distribution scheme discussed above applies.

Mighty-Dollar

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Re: Taxation of real estate index funds
« Reply #8 on: May 06, 2015, 01:14:40 AM »
And anyone have a response to my last question...
So to summarize both non-traded REITS and REIT index funds are taxed the same but index funds typically have lower dividend rates and therefore they probably work out as a tax savings? Is that what you all are saying?

seattlecyclone

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Re: Taxation of real estate index funds
« Reply #9 on: May 06, 2015, 08:08:01 AM »
Mutual funds are required to distribute all of their dividends. The yield of your index fund would then be the same as the weighted yield of the underlying stocks, and the taxation of those dividends would be the same as if you owned all of the stocks individually.

forummm

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Re: Taxation of real estate index funds
« Reply #10 on: May 06, 2015, 09:02:28 AM »
REIT index funds capital gains (when you buy/sell) and dividends are taxed the same as any other index fund. But they also have returns of capital that are taxed too.

https://personal.vanguard.com/us/funds/snapshot?FundId=5123&FundIntExt=INT#tab=4
You say return of capital is taxed, but just at the (lower) capital gains tax rate?  Is that what you're saying? Sounds like a raw deal if you're in a higher tax bracket. I know that capital gains taxes don't kick in until about $47,000 on income for the year.

So to summarize both non-traded REITS and REIT index funds are taxed the same but index funds typically have lower dividend rates and therefore they probably work out as a tax savings? Is that what you all are saying?

Looks like I was wrong about the return of capital.