Adding Real Estate To
Your Portfolio

Generally, corporations or trusts that qualify as REITs do not pay corporate income tax to the Internal Revenue Service. This means that, as long as certain stipulations are met, nearly all of a REIT's income can be distributed to shareholders, and there is no double taxation of the income to the shareholder. This potentially attractive benefit is another feature shared with mutual funds. Many states honor the federal tax treatment and do not require REITs to pay state income tax either. Unlike a partnership, however, REITs cannot pass on their tax losses to investors.

Another attractive feature of real estate investment trusts is that they are required by law to pay at least 95 percent of their earnings in the form of dividends to shareholders each year. Also, because they pay property and other taxes, REITs benefit the communities in which they invest.

The original REITs attracted only minimal interest from the investing public. At that time, the tax code permitted the use of real estate as a tax shelter. High debt levels and aggressive depreciation schedules allowed taxpayers to take interest and depreciation deductions that reduced their taxable income. These "paper losses" then were used to offset other income and decrease tax liability. Because REITs by law cannot pass on their losses to shareholders, they were unattractive to many investors who chose, instead, to own real estate directly.