A cash payment is not always profit. Check its character, then keep income and liquidity separate.
Income, returned capital and access to your money
A REIT has to distribute at least 90 percent of its taxable income each year, so distributions are the point of owning one. What arrives is not a single kind of money. The Form 1099-DIV the investor receives splits it into components, and each component has its own tax answer.
A distribution can include ordinary dividends. REIT ordinary dividends generally do not qualify for the reduced rates on qualified dividends. Use the character reported on Form 1099-DIV rather than treating every payment as the same kind of income.
Some payments return part of the investor’s own capital. A return of capital reduces the cost basis of the shares; it is not a new investment profit. In the simple example below, the payment is less than the starting basis.
Receiving distributions does not make a non-traded REIT liquid. Such shares have no ready exchange market, and repurchases may be limited or unavailable. Even listed shares can lose value. Income and the ability to recover the purchase price are separate questions.
In this below-basis example, every dollar of returned capital lowers basis by a dollar. That increases a later gain, or reduces a later loss, compared with using the original basis. The investor must use the adjusted basis; a future taxable gain is not guaranteed.
Exam terms
- Ordinary dividend
- The main component, included in ordinary income, generally without the reduced rate.
- Return of capital
- Returns invested capital and reduces basis; not taxed on receipt in this below-basis example.
- Adjusted cost basis
- What the shares are treated as having cost, after any return of capital.
- Form 1099-DIV
- The form that tells the investor how the distribution was split.
Income or returned capital?
| Ordinary dividend | Return of capital | |
|---|---|---|
| Taxed when received | Generally yes, as ordinary income | No in this example; reduces basis |
| Reduced dividend rate | Generally not available | Not a dividend |
| Effect on cost basis | None | Reduces it, dollar for dollar |
| On a later sale | No basis change from the dividend | Lower basis changes the reported gain or loss |
Try it: An investor buys REIT shares at $30 and over several years receives $12 a share classified as return of capital, then sells at $40. Work out the basis at the sale and the gain, and then work out what the gain would have been had none of the distribution been a return of capital.
The closest contrast
Ordinary dividend: taxed now.
Return of capital: reduces basis in this example.
Check the tax character shown for each component. A return of capital below basis is not taxed on receipt, but it reduces the basis used to calculate a later gain or loss.
Worked example
An investor buys REIT shares at $30 a share, receives $12 a share of return of capital over several years, and sells at $40. Assume no other basis adjustments or selling costs.
- None of the $12 was taxed when it arrived, because a return of capital is not a dividend.
- It reduced the adjusted cost basis from $30 to $18 a share.
- The sale at $40 therefore produces a gain of $22 a share rather than the $10 the purchase price alone would suggest.
- That $22 is the $10 the shares actually rose plus the $12 that was never taxed on the way through.
Check yourself
Try a question, then read the explanation to review the rule.
Opening your study record…
Same rule, new context
Opening your study record…
Summary
- A distribution’s character matters; receiving cash does not by itself mean the investment earned a profit.
- The ordinary component is taxed as ordinary income and generally does not get the reduced dividend rate.
- In this below-basis example, returned capital is not taxed on receipt and reduces adjusted basis.
- A non-traded REIT can distribute cash while its shares remain hard to sell.
- Returned capital changes the basis used on a later sale; it does not establish permanently tax-free profit.
Related practice
- Hedge fund structure and investor featuresPractice this
Sources
- SIE Examination Content Outline (2025) · FINRA · checked 2026-10-12
- Topic no. 404, Dividends (Internal Revenue Service) · IRS · checked 2026-09-04
- Investor Bulletin: Publicly Traded REITs (August 30, 2016) · Investor.gov · checked 2026-09-04
- Investor Bulletin: Publicly Traded REITs (August 30, 2016) · Investor.gov · checked 2026-09-04
- Investor Bulletin: Non-traded REITs — redemption programs, valuation, distributions, conflicts and filings (SEC Office of Investor Education and Advocacy, August 31, 2015) · Investor.gov · checked 2026-10-09