Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

What is a significant feature of REITs in terms of taxation?

1. Pay corporate tax on income

2. Tax-free at individual level

3. Avoid taxation of income at corporate level

4. Double taxation of income

The correct answer is: Avoid taxation of income at corporate level

Real Estate Investment Trusts (REITs) are designed to provide tax benefits that incentivize investment in real estate. A significant feature of REITs is the ability to avoid taxation at the corporate level. This occurs because REITs are required to distribute at least 90% of their taxable income to shareholders in the form of dividends. By adhering to this distribution requirement, REITs can maintain their status and avoid paying federal corporate income tax. Because they do not pay tax at the corporate level, the tax burden shifts to the individual shareholders who receive the dividends. This structure prevents the issue of double taxation typically faced by regular corporations, where income is taxed at both the corporate and the individual levels when profits are distributed as dividends. This unique tax treatment makes REITs an attractive investment option for investors looking for exposure to real estate while enjoying favorable tax benefits.