REITs do not pay tax on the distributable income they pay to investors, but pay tax on the income they keep. Usually, other types of income trusts and corporations are taxed on their income before distributions to investors, who are in turn taxed on the distributions they receive. Since a REIT’s distributions are only taxed in the investors’ hands, the marginal tax rate that applies to investor distributions is less than the combined corporate and investor tax rates for corporations. In short, REITs are not subject to the double taxation applied to dividends.
REIT distributions to investors keep their original form. For instance, if a REIT distributes what it originally received as rental income, you will be taxed at your marginal tax rate as though you had received rental income. The composition of these distributions for tax purposes may change over time, thereby affecting your after-tax returns.
REITs sometimes distribute amounts higher than what they can distribute, without compromising their production capacity and sustainability of distributions. In such cases, the surplus distribution may be considered a capital repayment. These are not usually taxable for investors, but reduce the basic price of the investor’s units for tax purposes. In other words, if you sell your units, you pay tax on the capital gain of any difference between the sales proceeds and the adjusted cost base at the time of sale. This is referred to as a deferred tax.
To ensure that you benefit from the tax advantages of an investment in REIT units, make sure the REIT complies with the conditions applicable to specified investment flow-through’s (SIFTs). An investment broker can help you determine if the units are eligible.
Prime Funds REIT units are eligible for RRSPs, TFSA’s, RRIFs and RESPs.