As an investment, REITs have long had advantages over owning property directly.
This advantage gap is widened by new federal tax rules.
As Generation X and millennials inherit their baby boomer parents’ assets amid the so-called Great Wealth Transfer, some will look to invest it in property to generate income.
This property might be a duplex, an apartment building or, depending on the location, a single-family house that could eventually become a retirement home.
Yet many aren’t aware that because of the various costs and risks involved, becoming a landlord — a role fraught with headaches — may not turn out to be profitable. A hands-off alternative to direct real estate investment are real estate investment trusts. These firms sell shares to investors, use the cash to buy residential, commercial and industrial property to lease out, and pay dividends to shareholders.
As an investment, REITs have long had advantages over owning property directly. This advantage gap is widened by new federal tax rules.
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A somewhat overlooked provision of the tax law that went into effect last year allows individuals hefty deductions on REIT income. Investors filing jointly with taxable income of less than $315,000 — and those filing individually with taxable income of $157,000 — are eligible for a 20% deduction. Investors with higher taxable income — up to $415,000 filing jointly and $207,000, individually—are eligible for deductions on a reduced scale.
While the tax legislation makes a REIT more attractive, it perhaps makes direct real estate investment less so. A provision that’s received widespread attention is the new $10,000 cap on the itemized deduction of state and local taxes, much is which is from property tax.
This has caused consternation aplenty in regions where high property values have long resulted in substantial deductions for homeowners. For investors in residential real estate, especially in expensive areas, this new provision is paring post-tax profits.
The tax legislation also reduces the maximum allowable amount of the purchase price for mortgage interest deductions from $1 million properties to those selling for $750,000.
These changes, along with the new deductions on REIT income, can mean improved net returns from investing in REIT shares as opposed to direct property ownership. Moreover, the new tax law includes business-tax changes beneficial to REITs and, ultimately, to their investors.
Most REITs are publicly traded like stocks, making them highly liquid — unlike most real estate investment trusts.
Like stocks, they’re bought and sold on major exchanges throughout the trading day. Some REITs own property used for a variety of purposes, but most specialize, variously owning real estate used for apartment buildings, health-care facilities, hotels, shopping malls, commercial office parks and industrial property for factories, on-line retailing fulfillment centers and server farms.
As some REITs can be highly specialized (such as cell phone towers), selecting them for investment should come after considerable analysis of specialized markets. REITs are considered an alternative asset — one that can diversify portfolios composed of traditional assets, such as stocks and bonds.
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