As the end of 2024 comes into sight, REITs have opportunities for tax planning with respect to year-end distributions. 

Dividends declared in October, November, or December, payable to shareholders of record in such month, and actually paid during January of the following year, are treated as paid on December 31 for both the REIT and the shareholders (Code section 857(b)(9)). Declaring in December (to shareholders of record in December) and paying in January provides REITs with a tool to avoid undesired return of capital distributions. Code section 857(b)(9) is particularly beneficial because it only applies to a distribution to the extent it is a dividend. As a result, if a REIT has $50 of earnings and profits and declares a $60 distribution in December 2024, paid in January 2025, then only $50 (the amount of earnings and profits) is recharacterized as a dividend paid in 2024. The remaining $10 paid in January is treated as a 2025 distribution and available to satisfy the 2025 distribution requirement. On the other hand, if the same REIT declared a $60 distribution in December 2024 and paid the $60 in December 2024, then the shareholders would have a $50 dividend and a $10 return of capital for 2024. With December payment, the REIT would not be able to use the $10 for purposes of satisfying its 2025 distribution requirement.

If a REIT has net operating losses, the REIT generally will not be able to use such net operating losses to reduce its taxable income to the extent that it pays a dividend. A REIT with net operating losses may choose to intentionally fail one of the requirements of Code section 857(b)(9) described above. For example, the REIT could declare a distribution in December to shareholders of record on January 1. Or, the REIT could declare a distribution in December payable on February 1. In both of these cases, the entire distribution would be treated for tax purposes as made in 2025, which could leave room for net operating losses to be used for 2024.

If a REIT still has undistributed taxable income after all 2024 distributions (including the December declaration mentioned above), then it can use distributions declared and paid in 2025 to satisfy its 2024 distribution requirement (Code section 858(a)). Such dividends must be declared prior to the time that the REIT files its 2024 tax return and paid during 2025 prior to the next regular distribution after the declaration. The REIT then elects to take a 2024 dividends paid deduction for such payments on its 2024 tax return. REIT shareholders, on the other hand, would include this distribution in income for 2025. A REIT using this strategy would owe a 4% nondeductible excise tax to the extent that the amount that it actually distributed during 2024 (including the December declaration described above) was less than 85% of its ordinary income and 95% of its capital gain net income (other than any retained capital gain on which tax is paid). Depending on borrowing costs, liquidity, and dividend and taxable income projections, a REIT may conclude that it makes sense to pay the nondeductible excise tax as a toll charge for delaying payments.

Finally, for REITs with few shareholders, the REIT can use the consent dividend procedure. A consent dividend requires the REIT to attach consents from its common shareholder(s) to the REIT’s tax return consenting to the amount of the dividend deemed paid and recontributed. Because of the need to obtain actual shareholder consents, this procedure is only practical for non-public REITs with concentrated shareholder bases.

If you have questions about the REIT distribution requirement and year-end distributions, please contact one of the members of our REIT tax team.