Table of Contents
- The potential for tax efficiency is one of several factors that may attract investors to invest in a REIT. [Jump to this section]
- A REIT’s tax structure is not affected by whether the REIT is privately held or publicly traded. [Jump to this section]
- When REITs are held in registered accounts, their taxation is subject to the tax rules of that account. [Jump to this section]
- When REITs are held in non-registered accounts, distributions may be taxed as return of capital or capital gains, resulting in a REIT’s potential tax-efficiency. [Jump to this section]
- Your tax advisor should be consulted regarding investment taxation prior to investing in a REIT. [Jump to this section]
Whether you’re considering investing in a REIT as an income supplement for retirement, to amass more wealth for a future inheritance to your loved ones, or simply to further grow your investment portfolio so you can achieve the lifestyle you want, you’ll need to consider the potential tax benefits that come with this type of real estate investment.
On the subject of REIT taxation, an article in the Financial Post states: “The clear advantage of a REIT is to reduce corporate and personal taxes on income paid to investors.”1 A report from Grant Thornton LLP agrees: “Since [their introduction to Canada], REITs have become an attractive, onshore, tax-efficient vehicle for investors…”2
The potential for tax efficiency is just one of many potential benefits of investing in a REIT, but it’s crucial to understand thoroughly as you evaluate potential REIT investment vehicles.
The (lack of) difference in taxation for public vs. private REITs
Although there are notable differences between public and private REITs, taxation is not one of them.
In terms of purchasing, valuation, liquidity, and eligibility, public and private REITs can be held in contrast to one another. However, REIT taxation is based upon the actual structure of a REIT investment fund rather than whether the REIT is publicly or privately held.
REIT taxation for RRSPs, TFSAs, RRIFs, and other registered accounts
When a REIT investment is held within a registered account, such as an RRSP, TFSA, or RRIF, REIT-specific tax rules don’t apply. The investment is only subject to the tax procedures and implications of the registered account itself.
Many investors choose to shelter their holdings within a registered account for this reason, as there are often potential tax advantages associated with holding savings or investments within RRSPs, TFSAs, and RRIFs for the long term.
- In the case of an RRSP, an investor’s REIT investment funds are tax-sheltered as long as the investment remains within the RRSP account. Growth will only be taxable at the time of withdrawal, with the level of taxation subject to the investor’s marginal tax rate. On December 31st of the year when the account holder reaches 71 years of age, they must roll the RRSP over into a RRIF account to continue sheltering the funds from taxation.
- RRIFs are structured to keep earnings tax-free, save for a set minimum amount paid out to the account holder, starting the year after the RRIF is set up and annually thereafter.
REIT taxation for non-registered accounts
Even if a REIT investment is not held within a registered account, many investors find the REIT-specific tax rules to be advantageous to the extent that REITs are an attractive addition to diversify their investment portfolio.
Distributions to REIT investors may be classified as return of capital or capital gains. Return of capital is a return paid by the investment that is not considered a taxable event at that point in time; instead it affects the investors adjusted cost base which would generally result in the investor realizing on disposition a larger capital gain. When investing in a REIT, all, or a portion, of an investor’s distributions are taxed as Return of Capital instead of income or capital gains.
As an investor continues to receive distributions in the form of return of capital, their Adjusted Cost Base is reduced by the amount of return of capital received that calendar year (read on to find out how this affects capital gains taxation).
In an Adjusted Cost Base calculation, the amount of return of capital received that year is subtracted from the previous years remaining Adjust Cost Base value.
As the investment is held over time, the Adjusted Cost Base continues to be further eroded (again, by the amount of return of capital received each year). If the investment is held long enough, the Adjusted Cost Base may eventually be reduced to zero. At that point in time, any distributions earned as return of capital would be taxed as a capital gain in that calendar year as there is no further cost base to deduct against (you cannot have a negative adjusted cost base). All prior year’s worth of deducting your return of capital against the adjusted cost base will be taxed as a capital gain at time of redeeming your holdings, therefore benefiting investors by pushing the taxation into the future.The amount of your Adjusted Cost Base helps to determine the amount an investor will be taxed as capital gains when they redeem their investment.
At the time of redemption—assuming an investor is redeeming at a value greater than their original investment—their Adjusted Cost Base is subtracted from the total amount of their investment holding. The resulting number is the amount they have realized in capital gains.
From there, only 50% of this capital gains amount (i.e. realized profit) is taxed at the investor’s marginal tax rate.
This treatment makes capital gains one of the most tax-efficient structures of investment returns. Some investors choose to engage in additional tax strategy such as tax-loss selling, to offset their capital gains taxation even further.
Factoring in potential tax benefits when evaluating a REIT
Compare the tax structure of REITs to that of dividends or interest income distributions from traditional investments.
Aside from taxation, there are plenty of other factors to consider when investing in a REIT – consider the checklist on this page as you research potential REIT investments. Among the many due diligence items to consider when evaluating a REIT investment, consultation with an investment advisor at the wealth management firm selling the REIT investment is key (in addition to consulting your accountant or tax advisor).
Beyond a productive conversation with an advisor, the accessibility of the REIT’s management team itself is a good indicator of client transparency, as well as sound operations within the REIT. The REIT’s management team should be able to provide a clear and transparent explanation of how the REIT operates and receives income, how this flows through to unitholders in the form of distributions, and how investor funds are taxed according to the type of account through which you’re investing. Accessibility to investors is second nature for those few wealth management firms, such as Skyline Wealth, that fall within the same entity or group of companies as the REIT funds they are offering.
A well-diversified investment portfolio will typically have a mix of investment vehicles, likely with differing taxation rules. REITs have been identified—and rightfully so—as an investment structure that may help offset varying types of taxation a traditional portfolio might hold (i.e. dividends, interest income, capital losses, etc.), and they can be an attractive investment option at any stage in an investor’s journey.
Vice President, Wealth Solutions
Ray Punn is an experienced leader in management across the public and private sectors, including the Financial, Automotive, and Private Equity industries. As Vice President of Skyline Wealth, he leads a comprehensive team of Advisors, and oversees business operations, marketing, investment management, and investor relations. With a deep understanding of how each component of wealth management contributes to an exceptional investor experience, Ray and his teams focus on building long-term partnerships with Skyline Wealth’s valued investors.
1 Mintz, Jack M. “Are REITs the next tax target?” Financial Post, https://financialpost.com/opinion/are-reits-the-next-tax-target. Accessed 9 July 2021.
2 “REITs as a force for good.” Grant Thornton, https://www.grantthornton.ca/globalassets/1.-member-firms/canada/insights/pdfs/grant-thornton-reits-report.pdf. Accessed 9 July 2021.
The contents of this article are for high-level, contextual purposes, and are not meant to replace advice from your accountant or any other tax advisor. We strongly suggest that an accountant or tax professional should be consulted prior to making an investment and should be used on an ongoing basis once an investment is made.