By Brett Owens
The IRS already allows REITs (real estate investment trusts) to avoid paying income taxes if they pay out most of their earnings to shareholders. As a result these firms tend to collect rent checks, pay their bills and send most of the rest of the cash to us as dividends.
But the IRS considers the dividends you and I receive from our REITs aEURoenonqualifiedaEUR dividends. This means they are taxed at our regular income rate.
Until now, that is. REIT investors will benefit from the tax breaks that aEURoepass throughaEUR businesses will receive in the 2018 tax code. Investors will be allowed deduct 20% of their REIT dividend income ( per U.S. News & World Report ).
Interestingly, REIT income will be taxed at a lower rate than regular rental income (which would not receive the deduction). Which means if you donaEURtmt have a burning desire to change light bulbs and play landlord yourself, it will be cost-effective to simply sit back, make a few clicks and buy real estate stocks instead of physical properties!
Many subscribers have written in lately asking about the tax status of other income investments, too. While each investoraEURtms tax situation is different, and I do not provide personalized tax advice, I have put together a general overview of the tax status of the dividends in our portfolio.
Municipal Bonds: Often Federal Tax-Exempt
Municipal aEUR" aEURoemuniaEUR aEUR" bonds are issued by states, cities, and counties to raise money, usually for capital projects like public transportation and infrastructure improvements. Folks in high tax brackets love them because the interest paid by munis is often tax-exempt at the federal and/or state level.
ThataEURtms right. The distributions you receive from funds such as the Nuveen Enhanced AMT-Free Municipal Credit Opportunities Fund ( NVG ) are federal tax-exempt. This means their listed nominal yield is actually much higher because of the tax advantage. And Nuveen provides a handy tool that lets you calculate the advantage aEUR" your aEURoetaxable equivalent yieldaEUR aEUR" on the fundaEURtms website, which you can access here :
What looks like an okay-but-not-good-enough-for us 5.37% becomes a juicy 9.07%.
Qualified Dividends: Maximum 20% Tax Rate
Investors receive aEURoequalified dividendsaEUR from the common shares they own in regular U.S. equities. Qualified dividends are taxed below the ordinary income rate. Their very favorable lower rate ranges from 0% to 20% depending on your tax bracket ( read the specifics according to Wells Fargo Advisors here ).
Closed-End Funds: A Mix of Tax Categories
Each closed-end fund ( CEF ) has one or more categories of income which are passed onto you, the investor. Your tax rate depends on the blend of these four potential sources:
- Interest payments
- Capital gains
- Return of capital
Fidelity has a comprehensive discussion of taxes on CEF distributions here .
For the specifics on how your fundsaEURtm distributions were classified in previous years, you should contact them directly. This information typically appears on fundsaEURtm websites. Also, Morningstar.com does provide a breakdown of the fundaEURtms latest distributions by income, short-term capital gains, long-term capital gains and return of capital. For example, hereaEURtms the breakdown for the BlackRock Floating Rate Strategies Income Fund ( FRA ) :
Remember managementaEURtms primary goal is to make sure its distribution is fully funded. As a result it usually doesnaEURtmt provide investors with a aEURoeforecastaEUR of how it plans to fund upcoming distributions, so that it has all options available at its disposal. But a quick review of previous distributions will give you a rough estimate of the current tax breakdown.
Avoiding the MLP aEURoeK-1 HeadacheaEUR
Master limited partnerships (MLPs) are required to issue you a K-1 package at the end of the tax year. These are generally headaches for the person who does your taxes aEUR" whether itaEURtms you or a professional.
A few years ago, my accountant calmly but sternly asked me to stop buying MLPs in my personal portfolio. I agreed, and I will return the favor to you too. There are better places to find high yield anyway, which is why we do not own any MLPs in our income-generating portfolios.
My Top 2 REIT Buys: Recession and Rate-Proof Landlords for 7.5%+ Yields with 25% Upside
Back to REITs aEUR" my two favorite tax-advantaged plays today are comfortably positioned in recession-proof industries. TheyaEURtmll have no problem continuing to raise their rents aEUR" and reward their shareholders aEUR" no matter what the Fed decides at its next meeting, what President Trump tweets or when the stock market finally takes a breather.
My favorite commercial real estate lender lets us play Monopoly from the convenience of our brokerage accounts. They do all the legwork, building a secure, diversified loan portfolio featuring offices, retail space, hotels and multifamily units.
Management then collects the monthly payments, deposits the checks, and then it sends most of the profits our way as dividends (a legal requirement to have A REIT status).
The stockaEURtms current dividend (a 7.7% yield today) is covered by earnings-per-share ( EPS ) today. And donaEURtmt be fooled by the stagnant dividend (not that stability is bad). The firm continues to originate an increasing number of loans:
Quarterly Origination Volume ($ in Billions)
This firm is a conservative lender with perfect loan performance (100%). Its growing portfolio will drive higher profits, which in turn will inspire the next dividend hike. The best time to buy the stock is right now, while it makes the investments which will drive its payout and share price higher from here.
Plus, this firm has also smartly eliminated interest rate risk because it uses floating rates. In fact, itaEURtms actually set up to make more money as interest rates move higher :
More Income as Interest Rates Rise
Same for another REIT favorite of mine, a 7.5% payer backed by an unstoppable demographic trend that will deliver growing dividends for the next 30 years. Interest rates are no problem for this landlord because it will simply continue raising the rents on its aEURoemust haveaEUR facilities.
Its founder Ed admitted that, fourteen years ago, he had aEURoezero assets, a dream, and a business plan.aEUR
Well, his dream and plan were plenty aEUR" the visionary entrepreneur parlayed them into $6.7+ billion in assets!
And right now is the best time yet to aEURoebet on EdaEUR because his growing base of assets is generating higher and higher cash flows, powering an accelerating dividend:
I love dividend increases because they are proof that management is actually making more money, so it can afford to pay us shareholders more. And an accelerating payout is a flat-out cry for help!
Any management team that raises its dividend faster and faster is clearly making more money than it knows what to do with. This usually happens when it achieves a tipping point where its machine no longer requires as much reinvestment to continue growing. So, leadership says: aEURoePlease, take a bigger raise, shareholders.aEUR
Meanwhile, investors and money managers who spot dividend accelerators lose their minds because, in theory, there is no valuation too high for a company that is increasing its dividend at an accelerating rate. Their spreadsheets literally break, and they buy the stock in a frenzy ( after we already own it, of course).
EdaEURtms stock should be owned by any serious dividend investor for three simple reasons:
- ItaEURtms recession-proof.
- It yields a fat (and secure) 7.5%.
- Its dividend increases are actually accelerating.
These two REITs are both aEURoebest buysaEUR in my 8% No Withdrawal Portfolio aEUR" an 8% dividend paying portfolio that lets retirees live on secure payouts alone. Now, as active recommendations for my premium subscribers, it wouldnaEURtmt be fair to reveal their names here.
But I would like to send you a free copy of my latest special report, Recession Proof REITs: 2 Plays With 7.5%+ Yields and 25% Upside , with all the details.
It includes the names, tickers and exact buy advice on how to start profiting right now.
In short, itaEURtms everything you need to know before you invest a single penny, and itaEURtms yours at no cost whatsoever. Click here and IaEURtmll share how you can get a complimentary copy of my premium REIT research .