The "Jobs and Growth" package signed into law last May cuts income tax rates on most dividends and capital gains received by individuals to a 15 percent maximum. Because REITs generally do not pay corporate taxes, the majority of REIT dividends will continue to be taxed as ordinary income at a new maximum rate of 35 percent (down from 38.6 percent).

However, REIT dividends will qualify for lower rates in the following instances: when the individual taxpayer is subject to a lower scheduled income tax rate; when a REIT makes a capital gains distribution (15 percent maximum tax rate); when a REIT contributes dividends received from a taxable REIT subsidiary or other corporation (15 percent maximum tax rate); and when, as permitted, a REIT pays corporate taxes and retains earnings (15 percent maximum tax rate).

How REIT Dividends Are Taxed

Source: NAREIT

Data indicates that about one-third of REIT dividends qualified for the lower 15 percent capital gains rate in 2003. As shown in the chart, of this amount, just over half (54 percent) represented capital gains distributions. Slightly less than half (46 percent) represented return of capital, which is taxed at a capital gain rate when the stock is sold.

Under the new tax law, dividends from preferred stocks are treated the same as common stock. This new law has no effect on tax-exempt investors, such as 401(k) plans, and the new rates will not apply to dividends or capital gains received by corporations.