IRC 857 REIT Taxation Form 1120-REIT Distribution Guide

Q: How is REIT taxable income calculated?

REIT taxable income is computed by starting with the REIT's regular taxable income under Subchapter C and then applying the modifications required by IRC 857(b). The key adjustments are: (1) capital gain net income is subtracted and stated separately, because it is subject to different distribution treatment; (2) the net operating loss deduction is computed under the REIT-specific rules in IRC 857(b)(2)(C), which limits the deduction to the amount of REIT taxable income for the carryback or carryforward year; (3) the special deductions allowed to corporations under IRC 241 through 250 (other than the dividends received deduction under IRC 243(a)(1)) are generally not available to REITs; and (4) the dividends paid deduction under IRC 561, as modified by IRC 857, is applied to reduce the resulting amount. The net result is that a REIT that satisfies the 90% distribution requirement typically reports near-zero corporate-level taxable income after the dividends paid deduction. Timing differences between REIT taxable income and GAAP net income (particularly from depreciation and straight-line rent adjustments) are a principal source of compliance risk. Practitioners should model REIT taxable income quarterly to avoid year-end distribution surprises. Verify current computation rules at IRS.gov.

Q: What is a capital gain dividend under IRC 857?

A capital gain dividend is a distribution that a REIT designates, pursuant to IRC 857(b)(3)(B), as derived from capital gain net income rather than ordinary income. A shareholder who receives an amount designated as a capital gain dividend treats that amount as long-term capital gain, regardless of how long the shareholder has held the REIT shares. The designation must be made in a written notice mailed to shareholders not later than 60 days after the close of the REIT's taxable year, typically in the REIT's annual report or in the final proxy materials sent to shareholders. The total amount a REIT may designate as capital gain dividends for any taxable year cannot exceed its capital gain net income for that year. As an alternative to paying a capital gain dividend, the REIT may elect under IRC 857(b)(3)(D) to retain the capital gain and pay corporate-rate tax on it, notifying shareholders via Form 2439 (and filing Form 2438 with the IRS); in that case shareholders are treated as having received and reinvested the retained capital gain and may claim a credit for their proportionate share of the tax paid. Verify current designation procedures and Form 2438/2439 requirements at IRS.gov.

Q: What is the IRC 4981 excise tax on REITs?

IRC 4981 imposes a 4% excise tax on a REIT's undistributed income for each calendar year. The excise tax is separate from, and operates independently of, the 90% distribution requirement under IRC 857(a)(1). Under IRC 4981(b), the Required Distribution for any calendar year equals the sum of: (1) 85% of the REIT's ordinary income for that calendar year; (2) 95% of the REIT's capital gain net income for that calendar year; and (3) any excess of required distributions from prior years over amounts actually distributed in those years (the roll-forward amount). The 4% excise tax applies to the amount by which the Required Distribution exceeds actual distributions made during the calendar year. Because the excise tax is computed on a calendar-year basis and the 90% distribution test is computed on a taxable-year basis, a REIT with a non-calendar taxable year must track both tests simultaneously. The REIT reports and pays the excise tax on Form 8612. Estimated excise tax payments may be required during the calendar year. Verify current rates, calendar-year computation rules, and Form 8612 filing requirements at IRS.gov.

Q: What is a prohibited transaction under IRC 857?

Under IRC 857(b)(6), a prohibited transaction is a sale or other disposition of property by a REIT where the REIT holds that property primarily for sale to customers in the ordinary course of a trade or business (i.e., dealer property within the meaning of IRC 1221(a)(1)). The tax consequence is severe: IRC 857(b)(6)(A) imposes a 100% excise tax on net income from a prohibited transaction. The 100% tax applies to net income, not gross proceeds, with no deduction for expenses allocable to the prohibited sale. A statutory safe harbor under IRC 857(b)(6)(C) is available if: (1) the REIT held the property for at least two years; (2) the total expenditures on the property during the two-year period prior to sale did not exceed 30% of the net selling price; (3) the REIT did not make more than seven sales of property (other than foreclosure property) during the taxable year (or, alternatively, the aggregate adjusted bases of properties sold did not exceed 10% of the aggregate bases of all REIT properties at the beginning of the year); and (4) the property was not acquired through foreclosure. Practitioners structuring property dispositions for REITs should evaluate each transaction against the safe harbor criteria before execution. Verify current safe harbor thresholds and conditions at IRS.gov.

Q: What is Form 1120-REIT?

Form 1120-REIT is the U.S. Income Tax Return for Real Estate Investment Trusts, filed annually with the IRS to report the REIT's taxable income, tax liability, dividends paid deduction, and capital gain designations. The form is structurally similar to Form 1120 (the standard corporate return) but includes REIT-specific schedules and lines reflecting the modified income computation rules of IRC 857. Key components include: the income section (gross income by category, tracking compliance with the 75% and 95% income tests of IRC 856); the deduction section (ordinary deductions, depreciation, net operating loss carryforwards computed under REIT rules); Schedule J (tax computation, including the dividends paid deduction and excise tax calculations); and Schedule K (shareholder information for distributable income characterization). The standard due date for Form 1120-REIT is the 15th day of the fourth month following the close of the REIT's taxable year (April 15 for calendar-year REITs), with an automatic six-month extension available on Form 7004. Capital gain dividend designations, Form 2438 (for retained capital gains), and Form 8612 (excise tax) are filed in connection with the annual return. Verify current Form 1120-REIT instructions and due dates at IRS.gov.

Q: Can a REIT cure a distribution deficiency?

Yes. IRC 860 provides the deficiency dividend procedure, which allows a REIT to cure a distribution deficiency that would otherwise cause loss of REIT status. If the IRS determines (in an examination, for example) that the REIT's REIT taxable income was higher than reported and therefore the REIT distributed less than the required 90%, the REIT may pay a deficiency dividend within 90 days of the IRS determination. The deficiency dividend is treated as paid during the taxable year of the deficiency for purposes of the dividends paid deduction, allowing the REIT to retroactively satisfy the 90% distribution requirement and preserve its REIT status. However, the procedure is not penalty-free: the REIT must also pay interest under IRC 6601 for the period running from the due date of the original return to the date of the deficiency dividend. In addition, the deficiency dividend procedure is available only when the deficiency is attributable to a determination within the meaning of IRC 860(e); it does not apply to self-discovered deficiencies outside of an IRS proceeding unless the REIT files a claim for adjustment. Practitioners discovering a potential deficiency should evaluate whether the 65-day rule, consent dividend procedure, or deficiency dividend procedure provides the most efficient cure. Verify current IRC 860 procedures and limitations at IRS.gov.

Q: How does OBBBA affect REIT distributions in 2026?

The One Big Beautiful Bill Act (OBBBA), enacted July 4, 2025, restored 100% bonus depreciation under IRC 168(k) for qualified property placed in service after January 19, 2025. For REITs, this has a counterintuitive effect on the 90% distribution requirement: because bonus depreciation is a deductible expense that reduces REIT taxable income below GAAP net income, a REIT with substantial 2025-2026 capital expenditures may find that its REIT taxable income is materially lower than its book income. The 90% distribution test is computed on REIT taxable income, not book income. Accordingly, the same dollar distribution that previously fell short of the 90% threshold (on higher taxable income) may now fully satisfy it (on lower taxable income reduced by bonus depreciation). This creates a potential cash conservation opportunity: the REIT may be able to distribute less cash while still satisfying the 90% requirement, retaining more cash for reinvestment or debt service. REITs should recalculate REIT taxable income projections on a quarterly basis in 2025 and 2026 to capture the bonus depreciation effect and right-size distributions. The DREIT structure affects dividend characterization for foreign investors, as discussed in the companion IRC 856 qualification guide. Verify current OBBBA effective dates and depreciation rules at IRS.gov.

1. REIT Taxable Income Computation

REIT taxable income is not the same as GAAP net income, and it is not the same as regular corporate taxable income. It is a specifically modified income figure computed under Subchapter C rules as adjusted by IRC 857(b). The computation is the foundation of every IRC 857 analysis: the 90% distribution requirement, the dividends paid deduction, the excise tax calculation, and the Form 1120-REIT schedules all trace back to it.

Step 1: Start with Regular Corporate Taxable Income

Begin with gross income reduced by ordinary and necessary deductions allowable under Subchapter C, including depreciation under IRC 167 and 168, interest expense (subject to any IRC 163(j) limitation), compensation, and other operating deductions. For 2025 and 2026 taxable years, bonus depreciation at 100% under OBBBA-amended IRC 168(k) for qualified property placed in service after January 19, 2025, is available and reduces this starting figure materially for REITs with active capital programs.

Step 2: Subtract Capital Gain Net Income

Capital gain net income is removed from the main income pool and stated separately under IRC 857(b)(2). This separation matters because capital gain net income is subject to the capital gain dividend rules of IRC 857(b)(3) rather than the ordinary dividends paid deduction. A REIT that sells appreciated property in a non-prohibited transaction generates capital gain net income that it may (but is not required to) distribute as a capital gain dividend.

Step 3: Apply REIT-Specific Modifications

Several ordinary corporate deductions are not available to REITs. The special deductions of IRC 241 through 250 (including the dividends received deduction under IRC 243 and the deduction for income attributable to domestic production activities) are generally disallowed for REITs. The net operating loss deduction is computed under the modified rules in IRC 857(b)(2)(C): the loss carryforward can only offset REIT taxable income from a year in which the entity qualifies as a REIT, and it is not available to the extent that the NOL arose in a non-REIT year.

Step 4: Apply the Dividends Paid Deduction

After the Subchapter C adjustments above, the REIT applies the dividends paid deduction under IRC 857(b)(2)(B) and IRC 561. The deduction equals qualifying distributions paid to shareholders during the taxable year (plus any carryover from the 65-day rule and consent dividends, discussed below). The result -- taxable income after the dividends paid deduction -- is the REIT's corporate-level tax base. If the REIT distributes at least 90% of its REIT taxable income, the deduction effectively eliminates corporate-level tax on the distributed amount.

Illustrative Income Computation Flow

Gross income: $10,000,000. Less ordinary deductions (including depreciation): ($7,500,000). Tentative corporate taxable income: $2,500,000. Less capital gain net income (stated separately): ($400,000). REIT taxable income before dividends paid deduction: $2,100,000. 90% distribution requirement: $1,890,000. Dividends paid (ordinary): ($1,900,000). REIT taxable income after dividends paid deduction: $200,000 (subject to corporate tax at 21%). This is a simplified illustration; actual computations involve additional modifications. Verify with current Form 1120-REIT instructions.

The timing difference between GAAP depreciation and tax depreciation (including bonus depreciation) is the most common source of discrepancy between book income and REIT taxable income. A REIT reporting positive GAAP net income may simultaneously have lower REIT taxable income due to accelerated tax depreciation -- or higher REIT taxable income due to straight-line book depreciation that runs slower than tax depreciation on older assets. Practitioners must model both.

2. The 90% Distribution Requirement (IRC 857(a)(1))

IRC 857(a)(1) conditions REIT status each taxable year on distributing at least 90% of REIT taxable income (exclusive of net capital gain). A REIT that fails this requirement for any taxable year loses its pass-through treatment for that year and is taxed as a regular C corporation on its entire taxable income.

Definition of "REIT Taxable Income" for Distribution Purposes

For purposes of the 90% test, REIT taxable income is computed without regard to the dividends paid deduction and without including net capital gain. The exclusion of net capital gain from the distribution base means that a REIT is not required to distribute its capital gains to satisfy the 90% test (though it must do so -- or pay corporate tax on retained gains -- to avoid the IRC 4981 excise tax on capital gain income). Undistributed ordinary income is the primary driver of the 90% calculation.

Qualifying Dividends Paid During the Taxable Year

To count toward the dividends paid deduction, a distribution must be a qualifying dividend under IRC 561. The distribution must be paid to shareholders in their capacity as shareholders, must not be a preferential dividend, and must be made out of current or accumulated earnings and profits. Stock dividends paid in the REIT's own shares generally do not qualify. Dividends paid in property (other than cash) may qualify if the property constitutes a distribution under Subchapter C.

The 65-Day Rule (IRC 857(b)(8))

Under IRC 857(b)(8), dividends declared before the close of a taxable year and paid within 65 days of year end may be treated as paid during the prior taxable year for purposes of the dividends paid deduction. To qualify, the dividend must be: (1) declared prior to the timely filing of the REIT's tax return (including extensions) for the taxable year to which it relates; and (2) paid within 65 days of the close of that taxable year. The 65-day rule is an important year-end planning tool: if a REIT determines in early January or February that it fell short of the 90% distribution threshold, it may cure the deficiency by paying an additional dividend before the 65-day window closes. Note that the dividend must be declared no later than the due date of the return (including extensions) to relate back; a dividend declared after the return due date does not qualify.

Consent Dividend Procedure (IRC 565)

Under IRC 565, a REIT may elect to treat a hypothetical dividend -- one that is not actually paid in cash or property -- as a qualifying distribution for purposes of the dividends paid deduction. A consent dividend requires shareholders to consent in writing to include their proportionate share of the hypothetical distribution in income and to increase their basis in REIT shares by that amount. Consent dividends are useful when the REIT lacks cash to pay a distribution but needs the deduction to satisfy the 90% requirement. The procedure requires all shareholders (or, in practice, sufficient shareholders) to file Form 972 with their returns.

Deficiency Dividend Procedure (IRC 860) -- Cross-Reference

If a distribution deficiency is discovered after the close of the taxable year (typically during an IRS examination or through a REIT's own self-assessment), IRC 860 provides a cure mechanism. The deficiency dividend procedure allows the REIT to pay an additional dividend after the close of the taxable year, treated as paid during the deficiency year for dividends paid deduction purposes, preserving REIT status. The procedure is subject to an interest charge under IRC 6601, making it a curative but not cost-free remedy.

3. Dividends Paid Deduction (IRC 561 / IRC 857(b)(2)(B))

The dividends paid deduction is the mechanism through which a REIT eliminates corporate-level tax on distributed income. Under IRC 857(b)(2)(B), REIT taxable income is reduced by the amount of the dividends paid deduction as computed under IRC 561. The deduction equals the sum of dividends paid during the taxable year (IRC 562), dividends paid within 65 days of year end that relate back under IRC 857(b)(8), and consent dividends elected under IRC 565.

Mechanics of the Deduction

The dividends paid deduction operates dollar-for-dollar: each dollar of qualifying ordinary dividend paid to shareholders reduces REIT taxable income by one dollar. Because the 21% corporate rate applies to REIT taxable income after the deduction, a REIT that distributes exactly 90% of its REIT taxable income retains 10% of REIT taxable income at the corporate level, subject to corporate income tax (and potentially the 4% excise tax under IRC 4981 if the calendar-year distribution falls short of the excise tax thresholds).

Preferential Dividend Limitation

A dividend is disqualified from the dividends paid deduction if it is a "preferential dividend" under IRC 562(c) -- that is, a dividend paid to one group of shareholders at a higher rate than dividends paid to another group of shareholders holding the same class of stock, without business justification. REITs with complex capital structures (including operating partnership units, preferred shares, or multiple classes of common stock) must analyze dividend payments for preferential dividend risk.

Relationship to IRC 4981 Excise Tax

The dividends paid deduction satisfies the 90% distribution test on a taxable-year basis. It does not independently satisfy the IRC 4981 excise tax, which is computed on a calendar-year basis using different thresholds (85% of ordinary income, 95% of capital gain income). A REIT must track both the taxable-year requirement (for the dividends paid deduction) and the calendar-year requirement (for IRC 4981) simultaneously.

4. Capital Gain Dividends (IRC 857(b)(3))

A REIT's capital gain net income is treated separately from ordinary income under IRC 857(b)(3). The REIT may elect to pass the long-term capital gain character through to shareholders by designating distributions as capital gain dividends, or it may retain the capital gain, pay corporate-rate tax on it, and pass the tax credit through to shareholders via Form 2439.

Capital Gain Dividend Designation (IRC 857(b)(3)(B))

Under IRC 857(b)(3)(B), a REIT may designate any distribution (or portion of a distribution) as a capital gain dividend. A shareholder who receives an amount properly designated as a capital gain dividend treats that amount as long-term capital gain regardless of the holding period in the REIT shares. The designated amount counts toward the dividends paid deduction as an ordinary dividend for purposes of the 90% distribution test (treating capital gain dividends as ordinary income for deduction purposes under IRC 857(b)(3)(A)), but is reported to shareholders as long-term capital gain on Form 1099-DIV (Box 2a).

Designation Procedure and Election

The capital gain dividend designation must be made by written notice mailed or delivered to shareholders not later than 60 days after the close of the REIT's taxable year. In practice, this is accomplished in the REIT's annual report or in the final proxy statement sent to shareholders. The total amount that may be designated as capital gain dividends for any taxable year cannot exceed the REIT's capital gain net income for that year. An informal board resolution, supplemental notice, or oral communication to investors is not sufficient -- the designation must appear in the required written notice sent to all shareholders within the 60-day window.

Retained Capital Gain Election (IRC 857(b)(3)(D))

As an alternative to distributing capital gains, a REIT may elect under IRC 857(b)(3)(D) to retain capital gain net income and pay corporate-level tax at the 21% rate on the retained amount. The REIT files Form 2438 (Undistributed Capital Gains Tax Return) with the IRS and notifies each shareholder via Form 2439 (Notice to Shareholder of Undistributed Long-Term Capital Gains). Each shareholder is then treated as having received a capital gain dividend equal to their share of the undistributed capital gain, is entitled to a credit for their proportionate share of the corporate tax paid by the REIT, and increases their basis in REIT shares by the amount of the deemed capital gain dividend reduced by the credit.

5. IRC 4981 Excise Tax on Undistributed Income

IRC 4981 imposes a 4% excise tax on the amount by which a REIT's Required Distribution for a calendar year exceeds its actual distributions during that year. The excise tax operates independently of the 90% distribution test: a REIT can satisfy the IRC 857(a)(1) 90% distribution requirement for its taxable year and still owe excise tax if it falls short of the IRC 4981 thresholds on a calendar-year basis.

Required Distribution Computation

Under IRC 4981(b), the Required Distribution for a calendar year equals the sum of:

85% of the REIT's ordinary income for the calendar year (the ordinary income Required Distribution floor);
95% of the REIT's capital gain net income for the calendar year; and
100% of any excess of the Required Distribution for any prior calendar year over actual distributions for that prior year (the roll-forward component).

The 4% excise tax applies to the amount by which the Required Distribution exceeds actual distributions made during the calendar year. Because the excise tax threshold for ordinary income (85%) is lower than the 90% taxable-year distribution requirement, a REIT that meets the 90% test does not automatically avoid excise tax -- the calendar-year computation uses a different base and different thresholds.

Excise Tax Return and Estimated Payments

The REIT reports and pays the annual excise tax on Form 8612 (Return of Excise Tax on Undistributed Income of Real Estate Investment Trusts). The Form 8612 is due by March 15 of the following calendar year. Estimated excise tax payments may be required during the calendar year. Practitioners should build the excise tax calculation into quarterly REIT taxable income projections to avoid year-end surprises and potential estimated tax underpayment issues.

6. Prohibited Transaction Tax (IRC 857(b)(6))

IRC 857(b)(6) imposes a 100% excise tax on net income from prohibited transactions. A prohibited transaction is a sale or other disposition of property held by the REIT primarily for sale to customers in the ordinary course of a trade or business -- in other words, a sale of dealer property within the meaning of IRC 1221(a)(1). The 100% rate is not punitive in the traditional sense: it is designed to eliminate any economic benefit from dealer-level property sales inside a REIT structure, because such sales are inconsistent with the passive investment nature that justifies REIT pass-through treatment.

Mechanics of the 100% Tax

The 100% tax applies to net income from the prohibited transaction: gross sales proceeds reduced by the REIT's adjusted basis in the property and by direct selling costs (commissions, closing costs). However, expenses not directly allocable to the sale -- general and administrative overhead, financing costs, management fees attributable to the property -- may not reduce the net income base for purposes of the 100% tax. A transaction that generates nominal net income after all costs can still produce a meaningful excise tax liability if the computation is restricted to direct selling expenses.

Statutory Safe Harbor (IRC 857(b)(6)(C))

A sale qualifies for the prohibited transaction safe harbor under IRC 857(b)(6)(C) if all of the following conditions are met:

The REIT held the property for at least two years prior to the sale;
Total expenditures (capital or otherwise) made by the REIT on the property during the two-year period prior to sale did not exceed 30% of the net selling price;
The REIT did not make more than seven sales of property (excluding foreclosure property) during the taxable year; or, alternatively, the aggregate adjusted bases of all properties sold during the year did not exceed 10% of the aggregate adjusted bases of all REIT properties as of the beginning of the year (the "10% basis alternative");
The property was not acquired through foreclosure or deed in lieu of foreclosure; and
If the property is land or improvements, the REIT was not in the business of subdividing the land or selling lots prior to the sale.

The seven-sale limit under the safe harbor counts sales across all properties sold during the taxable year, not just potential prohibited transactions. A REIT planning multiple dispositions in a single year must track the aggregate count and, if approaching the limit, evaluate whether the 10% basis alternative applies or whether one or more sales should be deferred.

Practical Structuring to Avoid Prohibited Transaction Classification

The most reliable approach is to sell properties through a taxable REIT subsidiary (TRS) rather than directly by the REIT. Because the TRS is a separate taxable entity subject to regular corporate income tax, sales by the TRS are not prohibited transactions at the REIT level. The TRS pays ordinary corporate tax at 21% on its gain, and the after-tax proceeds are distributed up to the REIT as a dividend (which is ordinary income to the REIT but qualifies for the 75% and 95% income tests as income from a qualified REIT subsidiary). This approach converts a potential 100% tax into a 21% corporate tax, at the cost of the tax itself and the structural complexity of maintaining a TRS.

7. Form 1120-REIT: Structure, Schedules, and Filing Requirements

Form 1120-REIT is the annual federal income tax return for qualifying real estate investment trusts. It reflects the modified income computation rules of IRC 857 and incorporates REIT-specific schedules not present on the standard Form 1120.

Income Computation Lines

Part I of Form 1120-REIT reports gross income by category, corresponding to the IRC 856 income test categories (rents from real property, mortgage interest, gains from property sales, dividends from other REITs, and other qualifying and non-qualifying income). The income breakdown feeds both the income test computation for IRC 856 qualification and the taxable income starting point for IRC 857. Non-qualifying income categories are identified separately to assess income test exposure.

Deduction Section and Dividends Paid Deduction Schedule

Part II reports deductions in a format similar to Form 1120, with adjustments for the REIT-specific modifications (disallowed special deductions, modified NOL rules). The dividends paid deduction is reported separately on Schedule B (Dividends Paid Deduction), which reconciles ordinary dividends paid during the taxable year, 65-day rule dividends, and consent dividends to arrive at the total dividends paid deduction applied on Page 1.

Capital Gain Designation

Capital gain net income and capital gain dividend designations are reported on Schedule J. The schedule requires identification of the total capital gain net income for the year, the amount designated as capital gain dividends (not to exceed capital gain net income), and any retained capital gain subject to the corporate-level tax and the Form 2438/2439 election.

Schedule K: Shareholder Information

Schedule K (Shareholders' Undistributed Taxable Income Previously Taxed, and Other Information) carries information relevant to REIT shareholders: the characterization of distributions between ordinary income, qualified dividends, capital gain dividends, and return of capital. This schedule drives the Form 1099-DIV reporting obligations to shareholders.

Due Dates and Extension

For calendar-year REITs, Form 1120-REIT is due on April 15. An automatic six-month extension is available by filing Form 7004 by the original due date, extending the filing deadline to October 15. The extension of time to file does not extend the time to pay any tax due. Form 8612 (excise tax return) has a separate due date of March 15 of the following calendar year and is not extended by a Form 7004 filed for the Form 1120-REIT.

8. OBBBA 2026 Interaction: Bonus Depreciation and Distribution Planning

The One Big Beautiful Bill Act, enacted July 4, 2025, restored 100% bonus depreciation under IRC 168(k) for qualified property placed in service after January 19, 2025. The restoration affects REIT taxable income computations beginning with the 2025 taxable year and continuing through the duration of the provision. For IRC 857 purposes, the interaction between bonus depreciation and the 90% distribution requirement creates both a compliance consideration and a cash planning opportunity.

The Bonus Depreciation Effect on REIT Taxable Income

When a REIT places qualified property in service after January 19, 2025, it may deduct 100% of the property's adjusted basis in the year of placement under IRC 168(k) as amended by OBBBA. This front-loaded depreciation deduction reduces REIT taxable income substantially in the year of acquisition. Because the 90% distribution requirement is computed on REIT taxable income (not GAAP net income, which continues to use straight-line depreciation over the asset's GAAP useful life), the required dollar distribution drops proportionally to the reduction in taxable income.

The Paradox: Lower Taxable Income Requires a Smaller Distribution

Bonus depreciation does not paradoxically require more distributions. It reduces REIT taxable income, and therefore reduces the dollar amount required to satisfy the 90% threshold. A REIT that reported $10 million of REIT taxable income in 2024 and was required to distribute $9 million may, in 2025, report only $6 million of REIT taxable income after bonus depreciation, requiring a distribution of only $5.4 million to satisfy the 90% test. The $3.6 million reduction in required cash distributions represents a potential cash conservation opportunity while still maintaining REIT qualification.

Quarterly Remodeling Requirement

Because the effect of bonus depreciation on REIT taxable income depends on the timing and volume of capital expenditures during the year, REIT taxable income projections can shift materially from quarter to quarter. A REIT that projected a $9 million required distribution based on January estimates may find by September that capital expenditures placed in service through that date have reduced the projection to $5 million. Practitioners should remodel REIT taxable income projections at each quarter end in 2025 and 2026 to right-size year-end distributions and avoid both over-distribution (which unnecessarily reduces retained cash) and under-distribution (which risks the 90% test or the IRC 4981 excise tax).

Planning Note: Bonus Depreciation and Cash Conservation

REITs with significant bonus depreciation deductions from qualified property placed in service after January 19, 2025 should remodel their REIT taxable income projections on a quarterly basis. Because 100% bonus depreciation under OBBBA reduces REIT taxable income below GAAP book income, the 90% distribution test may be satisfied by a smaller cash distribution than the prior year -- offering a meaningful cash conservation opportunity while fully maintaining REIT qualification. This effect is most pronounced in acquisition-heavy years; it reverses over time as book depreciation continues while tax depreciation has been fully exhausted. A five-year projection should account for the reversal. Verify current IRC 168(k) effective dates and phase-out schedules with current IRS guidance at IRS.gov.

DREIT Structure and Dividend Characterization

The OBBBA-related changes to the taxable REIT subsidiary ceiling (restored to 25% from 20%) and the permanent extension of the IRC 199A deduction for qualified REIT dividends also interact with IRC 857 distribution planning. For foreign investors, the domestically controlled REIT (DREIT) structure affects whether distributions are subject to FIRPTA withholding -- a characterization issue that begins with the dividend mechanics under IRC 857. Practitioners advising REITs with foreign investors should review the IRC 856 REIT qualification companion guide for the complete DREIT analysis, including the proposed regulations under Reg-109742-25.

9. IRC 857 REIT Taxation Quick Reference

IRC 857 Requirement / Provision	Threshold / Rate	Triggering Event	Remedy / Election
90% Distribution Test (IRC 857(a)(1))	90% of REIT taxable income (excluding net capital gain)	Failure to distribute required amount by year end (or within 65-day carryover window)	65-day rule (IRC 857(b)(8)); consent dividend (IRC 565); deficiency dividend (IRC 860)
Dividends Paid Deduction (IRC 561 / IRC 857(b)(2)(B))	Dollar-for-dollar reduction of REIT taxable income	Qualifying ordinary dividend paid (or deemed paid) to shareholders	Ensure distributions are qualifying dividends; avoid preferential dividend classification
Capital Gain Dividend Designation (IRC 857(b)(3)(B))	Not to exceed capital gain net income for the year	REIT elects to designate a distribution as a capital gain dividend in the required written notice	Written notice to shareholders within 60 days of year end; annual report or final proxy
Retained Capital Gain Election (IRC 857(b)(3)(D))	Corporate tax rate (21%) on retained capital gain	REIT retains capital gain rather than distributing it	File Form 2438; notify shareholders via Form 2439; shareholders claim corresponding credit
IRC 4981 Excise Tax on Undistributed Income	4% of excess of Required Distribution over actual distributions	Calendar-year distributions fall short of 85% of ordinary income / 95% of capital gain income	Increase calendar-year distributions; report and pay on Form 8612 (due March 15)
65-Day Rule (IRC 857(b)(8))	Dividend paid within 65 days of year end	Dividend declared before return due date and paid within 65-day window	Declare prior-year dividend before return due date (including extensions); pay within 65 days of year end
Consent Dividend (IRC 565)	Hypothetical distribution; no cash outlay required	REIT elects consent dividend; shareholders consent in writing	Shareholders file Form 972; increase basis in REIT shares by consented amount
Deficiency Dividend Procedure (IRC 860)	Deficiency dividend paid within 90 days of IRS determination	IRS determines distribution deficiency; REIT pays additional dividend	Pay deficiency dividend within 90 days; pay IRC 6601 interest for deficiency period
Prohibited Transaction Tax (IRC 857(b)(6))	100% of net income from prohibited transaction	REIT sells property held primarily for sale to customers in the ordinary course of business	Satisfy statutory safe harbor (IRC 857(b)(6)(C)); or sell through TRS entity
Prohibited Transaction Safe Harbor (IRC 857(b)(6)(C))	7 sales per year maximum (or 10% basis alternative); 2-year holding period required	Sale of property not qualifying as dealer property under safe harbor criteria	Hold property for 2 years; limit sales count; satisfy expenditure threshold (30% of net selling price)
Form 1120-REIT Filing Obligation	Annual return; due April 15 (calendar year); 6-month extension on Form 7004	Any entity electing and maintaining REIT status	File timely; attach Form 2438 (retained capital gain), Form 8612 (excise tax) as applicable
OBBBA Bonus Depreciation Interaction (IRC 168(k))	100% bonus depreciation for property placed in service after January 19, 2025	REIT acquires qualified property; bonus depreciation reduces REIT taxable income	Remodel REIT taxable income quarterly; adjust distribution amounts to reflect lower taxable income base

10. Compliance Traps

Critical Risk: 90% Test Based on REIT Taxable Income, Not GAAP

The 90% distribution requirement is computed on REIT taxable income, not GAAP net income. A REIT reporting positive GAAP income may fail the distribution test if REIT taxable income is higher than book income -- for example, because GAAP straight-line rents inflate book income in excess of amounts taxed currently, or because book depreciation runs at a slower rate than accelerated tax depreciation on certain assets. The reverse is equally important: in bonus depreciation years, REIT taxable income may be far lower than GAAP income, meaning the required distribution is smaller than the board's book-income-based estimate would suggest. Practitioners must maintain a separate REIT taxable income model and must never rely solely on audited GAAP financial statements to assess distribution compliance.

Critical Risk: 100% Tax Applies to Direct Net Income With No Overhead Allocation

The 100% prohibited transaction tax under IRC 857(b)(6) is computed on net income from the prohibited sale, with no deduction for overhead expenses, general administrative costs, or financing costs allocated to the property. A REIT that sells a property and calculates a small or negligible overall profit after allocating all holding costs may find that the direct net income -- gross proceeds less adjusted basis less direct selling commissions and closing costs only -- is material, producing a significant 100% tax liability. A REIT sale that generates nominal overall net income can still generate a meaningful 100% tax. Practitioners must run a separate prohibited transaction net income calculation on every proposed disposition, and must evaluate the statutory safe harbor before execution.

Practitioner Alert: 65-Day Rule Requires Declaration, Not Just Payment

Under IRC 857(b)(8), a dividend paid within 65 days of year end relates back to the prior taxable year only if the dividend was declared no later than the due date of the REIT's return for the prior year (including extensions). A dividend declared in January of the following year does not automatically relate back: if the January declaration date precedes the return due date, relation back is available; if the REIT has not filed for extension and the return due date has already passed, it does not. Practitioners managing year-end distributions must confirm both the declaration date and the return due date (including extension status) before relying on the 65-day rule to cure a distribution shortfall.

Practitioner Alert: Capital Gain Designation Requires Written Notice -- Board Resolution Is Not Sufficient

The capital gain dividend designation under IRC 857(b)(3)(B) must be made in a written notice mailed or delivered to shareholders within 60 days after the close of the REIT's taxable year. An informal board resolution designating distributions as capital gain dividends, a supplemental investor letter issued after the annual report, or an investor-relations posting on the REIT's website does not satisfy the statutory written notice requirement. If the designation is not timely and properly made, shareholders receive ordinary dividend treatment on the full distribution, regardless of the REIT's intent. Confirm the designation appears in the annual report or final proxy and that the mailing date falls within the 60-day window.

Practitioner Alert: Deficiency Dividend Cures Status But Not Interest

The deficiency dividend procedure under IRC 860 is a REIT status-preservation mechanism, not a cost-free cure. A REIT that pays a deficiency dividend to cure a distribution shortfall discovered during an IRS examination must also pay interest under IRC 6601 computed from the due date of the original return for the deficiency year through the date the deficiency dividend is paid. For deficiencies discovered two, three, or four years after the original return, the IRC 6601 interest can represent a material additional cost on top of the tax otherwise avoided. Practitioners should quantify the IRC 6601 interest exposure as part of the examination response analysis before recommending the deficiency dividend procedure.

11. Frequently Asked Questions

What is the 90% distribution requirement for REITs?

Under IRC 857(a)(1), a REIT must distribute to its shareholders as dividends at least 90% of its REIT taxable income for each taxable year, computed without regard to the dividends paid deduction and by excluding net capital gain. REIT taxable income for this purpose differs from both GAAP net income and regular corporate taxable income. A REIT that fails to distribute the required 90% loses its ability to deduct dividends paid and is subject to full corporate-level tax on its undistributed income for that year. The 65-day rule (IRC 857(b)(8)) and the deficiency dividend procedure (IRC 860) provide mechanisms to cure a deficiency, subject to conditions and, in the case of IRC 860, an interest charge. Verify current thresholds at IRS.gov.

How is REIT taxable income calculated?

REIT taxable income begins with regular corporate taxable income under Subchapter C and is then modified by IRC 857(b): capital gain net income is removed and stated separately; most corporate special deductions (IRC 241 through 250) are disallowed; the net operating loss deduction follows REIT-specific carryforward rules; and the dividends paid deduction under IRC 561 is applied. The result is the REIT's corporate-level tax base. Because REIT taxable income uses tax depreciation (including bonus depreciation under OBBBA) rather than GAAP straight-line depreciation, it frequently diverges from GAAP net income. Practitioners must model REIT taxable income separately from GAAP financials. Verify current computation rules at IRS.gov.

What is a capital gain dividend under IRC 857?

A capital gain dividend is a distribution (or portion of a distribution) that a REIT designates under IRC 857(b)(3)(B) as derived from capital gain net income. Shareholders treat designated amounts as long-term capital gain regardless of their REIT share holding period. The designation must be made by written notice to shareholders within 60 days after year end (typically in the annual report or final proxy) and cannot exceed the REIT's capital gain net income for the year. As an alternative, the REIT may retain the capital gain under IRC 857(b)(3)(D), pay corporate tax, and notify shareholders via Form 2439. Verify current designation procedures at IRS.gov.

What is the IRC 4981 excise tax on REITs?

IRC 4981 imposes a 4% excise tax on the amount by which a REIT's Required Distribution for a calendar year exceeds actual distributions for that year. The Required Distribution equals 85% of ordinary income plus 95% of capital gain net income plus 100% of any prior-year excess. The excise tax is separate from the 90% taxable-year distribution requirement and is reported and paid on Form 8612, due March 15 of the following year. A REIT that satisfies the 90% taxable-year requirement may still owe excise tax if its calendar-year distributions fall short of the IRC 4981 thresholds. Verify current rates and Form 8612 requirements at IRS.gov.

What is a prohibited transaction under IRC 857?

A prohibited transaction under IRC 857(b)(6) is a sale or disposition of property held by the REIT primarily for sale to customers in the ordinary course of a trade or business (dealer property under IRC 1221(a)(1)). The 100% excise tax applies to net income from such a sale, computed on direct revenues less adjusted basis and direct selling costs only. The statutory safe harbor under IRC 857(b)(6)(C) is available if the REIT held the property for at least two years, made no more than seven property sales during the taxable year (or satisfies the 10% basis alternative), and meets the expenditure threshold. Verify current safe harbor criteria at IRS.gov.

What is Form 1120-REIT?

Form 1120-REIT is the annual federal income tax return for qualifying real estate investment trusts. It reports REIT taxable income under the IRC 857(b) modified computation rules, the dividends paid deduction (Schedule B), capital gain designations (Schedule J), and shareholder information (Schedule K). The return is due April 15 for calendar-year REITs, with a six-month automatic extension available on Form 7004. Form 8612 (excise tax) and Form 2438 (retained capital gains) are filed separately. Verify current Form 1120-REIT instructions and due dates at IRS.gov.

Can a REIT cure a distribution deficiency?

Yes. Three mechanisms are available depending on timing. The 65-day rule (IRC 857(b)(8)) allows dividends declared before the return due date and paid within 65 days of year end to relate back to the prior year. The consent dividend procedure (IRC 565) allows the REIT to treat a hypothetical distribution as paid without a cash outlay if shareholders consent. The deficiency dividend procedure (IRC 860) allows the REIT to pay a cash dividend after the close of the taxable year following an IRS determination, treating it as paid during the deficiency year -- but the REIT must pay interest under IRC 6601 for the deficiency period. The procedure preserves REIT status but is not penalty-free. Verify current procedures at IRS.gov.

How does OBBBA affect REIT distributions in 2026?

OBBBA (enacted July 4, 2025) restored 100% bonus depreciation under IRC 168(k) for qualified property placed in service after January 19, 2025. Because bonus depreciation reduces REIT taxable income below GAAP net income, the 90% distribution requirement may be satisfied by a smaller cash distribution in years with significant capital expenditures. REITs should remodel REIT taxable income projections quarterly to capture the bonus depreciation effect and right-size year-end distributions -- avoiding both over-distribution (unnecessary cash outflow) and under-distribution (excise tax risk). OBBBA also restored the TRS asset ceiling to 25% and made the IRC 199A qualified REIT dividend deduction permanent. Verify current OBBBA effective dates at IRS.gov.

Related Practitioner Guides

IRC 856 REIT qualification: income tests, asset tests, TRS ceiling, DREIT structure, and OBBBA 2026 changes.
IRC 1031 like-kind exchange: deferral of gain on real property dispositions relevant to REIT asset management and portfolio rebalancing.
IRC 1231 property: netting rules and lookback applicable to gain from REIT property dispositions that generate capital gain net income.
IRC 1411 net investment income tax: REIT dividends as net investment income for individual and trust investors receiving REIT distributions.
Section 199A qualified REIT dividends: the 20% deduction for qualified REIT ordinary dividends received by non-corporate investors, made permanent by OBBBA.
IRC 860 REMIC deficiency dividend procedures: deficiency dividend procedures applicable to REMICs and the excess inclusion income pass-through to REIT shareholders.
IRC 860A-860G REMIC qualification and taxation: REMIC qualification tests, residual interest excess inclusion income, prohibited transactions, and Form 8811 reporting for practitioners.

REIT Taxation Compliance and Planning

Americas Tax advises REITs, their counsel, and investors on IRC 857 REIT taxation, Form 1120-REIT review, distribution requirement planning, capital gain dividend designations, and OBBBA 2026 strategy. Contact us to schedule a practitioner-level consultation.

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