Though the fiscal cliff is over, investors haven't breathed a sigh of relief.
Sure, the indices ramped higher following the deal struck between Republicans and Democrats on January 1. However, many analysts agree that higher taxes may hurt GDP this year.
The cliff solution involved a combination of postponing spending cuts and implementing tax increases. The tax hikes were less than expected, but noticeable nonetheless.
First, the 2% payroll tax cut was not renewed. Additionally, tax rates will climb to 39.6% for households making more than $450,000 per year - something that doesn't affect 98% of the U.S. population. Capital gains and dividend taxes also increased to 20% for households in this tax bracket.
The higher tax rate on dividends is a big deal for wealthy income investors whose tax exposure went up by as much as 33%.However, one dividend investment benefitted from those higher tax rates. In fact, many owners were actually cheering for even higher taxes.
Though REIT (real estate investment trust) owners have many tax advantages, low capital gains and dividends tax rates aren't among them. The government taxes REIT investments at the same rate as ordinary income.
However, the fiscal cliff compromise brought tax rates on capital gains, dividends and REIT income closer to parity because the top rate for capital gains is now 20%. This policy shift could spark a huge demand from investors for REITs.
Favorable tax adjustments and an income-craving generation of baby boomers put REITs back in the spotlight. REITs allow investors to own property simply by purchasing a stock. And REITs aren't focused in traditional real estate. A REIT can be a timber company or cell phone tower firm - even a prison can file as a REIT.
Moreover, REITs are liquid investments, allowing investors to buy or sell them any day that the stock market is open. They are designed to generate positive cash flow and are required by law to pay at least 90% of their income to shareholders by way of a cash dividend.
The lower tax rates on capital gains and dividend investments continue to give each an edge over REITs. However, that advantage is narrowing. In fact, it could be erased altogether.
The U.S. fiscal cliff circus was merely a sideshow compared to the upcoming debt ceiling negotiations. Expect Congress to impose greater spending cuts and talk about more tax hikes in the months ahead.
Many experts believed that dividends would revert to being taxed at income levels. The rate went up to 20% for some households, but that's historically low and is likely to increase.
As debt-ceiling talks intensify, Democrats may seek to negotiate higher capital gains and dividend taxes in return for lofty Republican-backed spending cuts. If this occurs, dividends would have no advantage over REITs, making them a great investment for capital gains and income.
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