When seeking investor funds for a real estate transaction, the higher the expected yield on the investment, the more capital will be available. Structuring the investment entity as a real estate investment trust (REIT) can help increase the yield by lowering the tax liability on the investment.
First, a REIT eliminates one level of taxation by allowing the REIT to deduct all dividends paid to its investors provided the REIT pays at least 90 percent of its otherwise taxable income in dividends. Most REITs distribute 100 percent of their taxable income, thus incurring zero federal (and in many cases, state) income taxes. Because a REIT distributes most, if not all, of its taxable income to its investors, a REIT cannot increase its real estate assets by reinvesting internally generated funds in the business. Accordingly, a REIT will need access to additional capital to grow its business.
Second, if investment capital will come from entities subject to the unrelated business taxable income (UBTI), such as endowment funds and foreign investors, a REIT blocks the imposition of the UBTI.
The avoidance of either of these taxes will result in a higher yield on the investment and, consequently, easier access to capital.
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