SIE Understanding Products and Their Risks Question 19: Answer and Explanation

Question: 19

Which of the following is a requirement of real estate investment trusts (REITs) in order to avoid double taxation on dividends?

• A. It must hold all dividends, interest, and realized capital gains until maturity.
• B. At least 90 percent of its ordinary income must be distributed to investors.
• C. At least 95 percent of its gross income must be derived from dividends, interest, and rents from real property.
• D. At least 75 percent of its gross income must be derived from real property income.

Correct Answer: B

Explanation:

B: The Internal Revenue Code requires substantially all (90 percent) of ordinary income to be distributed to investors to merit pass-through tax treatment, which eliminates double taxation of dividends. Otherwise, the REIT would pay income tax on its income, and the investor would then pay income tax on dividends from the REIT. Choice A is incorrect because 90 percent of ordinary income from assets must be distributed to investors. Choices C and D are requirements in order for 20 percent of the income distributed by an REIT to be nontaxable, which is another attractive REIT tax benefit to investors.