Tax Planning Opportunities for REITs as 2024 Draws to a Close

As the end of 2024 approaches, real estate investment trusts (REITs) find themselves at a pivotal juncture for effective tax planning, particularly with year-end distributions. Strategic decisions made now can have significant implications for the tax obligations of both the REIT and its shareholders. Understanding the regulatory landscape, especially concerning IRS Code section 857(b)(9), can empower REITs to optimize their financial standings while minimizing undesired tax consequences.

The Benefits of Year-End Distributions

One of the most advantageous aspects of REIT distribution planning lies in the treatment of dividends declared in the fourth quarter. As per Code section 857(b)(9), dividends declared in October, November, or December – payable to shareholders of record in the same month and actually paid in January of the subsequent year – are considered paid as of December 31 for both the REIT and the shareholders. This creates a flexible environment where REITs can efficiently manage their distributions to shareholders.

For example, if a REIT reported $50 of earnings and profits and declared a $60 distribution in December 2024, payable in January 2025, the financial implications are clear. Only $50 of this distribution would be recharacterized as a dividend for 2024, while the remaining $10 would count as a distribution in 2025. This planning strategy allows REITs to satisfy their distribution requirements for 2025 while potentially mitigating the adverse tax effects on their shareholders, such as return of capital.

Mitigating Return of Capital Distributions

Declaring a distribution in December and paying it in January not only provides timing benefits for the REIT but also helps avoid the complications associated with return of capital distributions. If the same REIT had declared the full $60 distribution in December 2024 and paid it out in that month, shareholders would receive a $50 dividend and $10 categorized as a return of capital for tax purposes. Consequently, this distribution strategy would also hinder the REIT from using any portion of the return of capital to meet its 2025 distribution requirement.

Moreover, it is crucial for REITs managing net operating losses (NOLs) to consider how these distributions align with their taxable income strategies. REITs typically cannot utilize NOLs to lower taxable income when dividends are declared. To sidestep this challenge, a REIT may choose to declare a distribution in December for the record date in January or a later date, effectively postponing the tax implications into the following year. This approach could allow the REIT the opportunity to leverage NOLs while still providing necessary returns to its shareholders.

Navigating Undistributed Taxable Income

REITs that find they have undistributed taxable income at the end of 2024 can further explore options in 2025. As outlined in Code section 858(a), a REIT has the capability to declare and pay distributions in 2025 that can count towards satisfying its 2024 distribution requirement. However, to take advantage of this provision, these distributions must be executed prior to the REIT filing its 2024 tax return, underscoring the need for meticulous planning and execution.

Shareholders should also be aware that any dividends paid in this manner will be included in their taxable income for 2025. Consequently, reported income will be deferred, which could be beneficial depending on the individual shareholder’s financial situation and tax strategy.

The Trade-Off: Nondeductible Excise Tax

Utilizing flexible distribution strategies, such as those provided by Code section 858, can have implications beyond immediate tax savings. REITs must consider the 4% nondeductible excise tax that will apply if distributions for 2024 fall below 85% of ordinary income or 95% of capital gains (excluding retained capital gains). This tax acts as a financial burden or “toll charge” for REITs that choose to defer payments or utilize other tactics to manage distributions.

Such tax planning necessitates careful consideration of various factors including liquidity, borrowing costs, and future income projections. Each REIT will need to assess its situation individually to determine the most economically viable path forward.

Consent Dividend Procedures for Non-Public REITs

For REITs with a concentrated shareholder base, particularly non-public ones, the consent dividend procedure provides another unique strategy. By obtaining shareholder consents to accept a dividend that shall be deemed paid and recontributed, these REITs can manage their taxation and distribution strategies in a way that is mutually beneficial. The practicality of this approach, however, limits its use to those REITs with fewer shareholders.

Conclusion

As 2024 winds down, REITs must navigate a complex landscape of tax planning opportunities surrounding year-end distributions. Utilizing strategies outlined in Code sections 857 and 858 can assist in maximizing the value delivered to shareholders while minimizing adverse tax consequences. By postponing distributions thoughtfully, leveraging net operating losses where possible, and considering consent dividend options, REITs can adopt a proactive stance to successfully maneuver the implications of year-end tax considerations. As always, consulting with tax professionals and financial advisors can further enhance these strategic decisions and optimize outcomes for both the REIT and its shareholders.

Emily Benedict also contributed to this article.