Table of Contents
SERIES 7 | SERIES 63 | SERIES 65 | FINANCIAL REGULATION COURSES
A real estate investment trust is a corporation, trust, or association that owns, operates, or finances income-producing real estate — or holds mortgages on real property — and that qualifies under Subchapter M of the Internal Revenue Code for special pass-through tax treatment allowing it to avoid corporate-level income tax on earnings distributed to shareholders, provided it satisfies comprehensive qualification requirements governing its organisational structure, the composition of its assets, the sources of its income, and the minimum amount it distributes annually. REITs were created by Congress under the Real Estate Investment Trust Act of 1960 — enacted as part of the Cigar Excise Tax Extension Act of 1960 — to allow individual investors to participate in large-scale, income-producing real estate in the same way that mutual funds allow participation in diversified securities portfolios. They are tested throughout the Series 7, Series 65, and SIE examinations in the context of investment products, tax-advantaged structures, income investing, and portfolio diversification.
The definition of a real estate investment trust and the requirements for REIT qualification are codified in Internal Revenue Code Section 856, with the distribution requirements in IRC Section 857 and the excise tax on underdistribution in IRC Section 4981. The Treasury regulations implementing these provisions are at 26 CFR Part 1, Sections 1.856-1 through 1.856-10.
To qualify as a REIT under IRC Section 856(a), an entity must be organised as a corporation, trust, or association that would otherwise be taxable as a domestic corporation. It must be managed by one or more trustees or directors. Its beneficial ownership must be evidenced by transferable shares or transferable certificates of beneficial interest. It must have at least one hundred beneficial owners — with no more than fifty percent of its shares held by five or fewer individuals applying the attribution rules of IRC Section 544 at any time during the second half of its taxable year, the so-called five-or-fewer test or closely held corporation test. Finally, it must not be a financial institution or an insurance company under the applicable Code provisions.
The qualification requirements fall into three categories — asset tests, income tests, and distribution requirements — each of which must be satisfied annually or quarterly as specified.
IRC Section 856(c)(4) imposes asset composition requirements tested at the close of each quarter of the taxable year.
At least seventy-five percent of the value of a REIT's total assets must be represented by real estate assets, cash and cash items including receivables, and government securities. Real estate assets are defined in IRC Section 856(c)(5)(B) as real property — including interests in real property and interests in mortgages on real property — and shares in other qualifying REITs. This seventy-five percent asset test ensures that the REIT's balance sheet is dominated by real estate and liquid assets rather than unrelated investments.
No more than twenty-five percent of a REIT's total assets may be represented by securities other than those qualifying for the seventy-five percent test. Within that twenty-five percent basket, no more than twenty percent may be represented by securities of taxable REIT subsidiaries — corporate subsidiaries through which a REIT may conduct non-qualifying activities such as hotel management or other active businesses without tainting the REIT's own qualification. Securities of any single non-REIT issuer may not exceed five percent of the REIT's total assets.
IRC Section 856(c)(2) and Section 856(c)(3) impose two separate gross income tests that must each be satisfied annually.
The seventy-five percent gross income test requires that at least seventy-five percent of the REIT's gross income be derived from qualifying real estate sources — primarily rents from real property, interest on obligations secured by mortgages on real property, gain from the sale of real property, dividends from other qualifying REITs, and certain other real estate-related income enumerated in Section 856(c)(3). This test ensures that income generation is directly tied to real estate ownership and financing rather than to unrelated business activities.
The ninety-five percent gross income test — which existed in its original form and has been modified over legislative cycles — requires that at least ninety-five percent of gross income be derived from qualifying real estate sources plus dividends, interest, and gains from the sale of securities. This broader ninety-five percent test captures passive investment income alongside real estate income and ensures that the vast majority of the REIT's revenue comes from passive rather than active business operations.
Failure of either income test triggers adverse tax consequences unless the failure was due to reasonable cause, was not wilful neglect, and the REIT pays a tax equal to the amount of income that caused the failure multiplied by the highest corporate tax rate.
The most examination-critical qualification requirement for investment professionals is the distribution mandate under IRC Section 857(a)(1), which requires a REIT to distribute to its shareholders at least ninety percent of its REIT taxable income for the taxable year, computed without regard to the deduction for dividends paid and by excluding net capital gains. This ninety percent distribution requirement — frequently rounded to ninety percent in examination questions — is the provision that gives REITs their defining income-producing character and is the key distinction between a REIT and a standard real estate holding company.
By distributing at least ninety percent of taxable income, the REIT qualifies for a dividends paid deduction under IRC Section 561 that eliminates the corporate-level tax on the distributed income, allowing the full pre-tax income to pass through to shareholders who pay individual income tax on distributions received. A REIT that retains more than ten percent of taxable income pays corporate-level tax on the retained amount at the standard twenty-one percent corporate rate established by the Tax Cuts and Jobs Act of 2017.
IRC Section 4981 imposes a four percent excise tax on any REIT that fails to distribute a minimum amount each calendar year — calculated as the sum of eighty-five percent of ordinary REIT income, ninety-five percent of capital gain income, and one hundred percent of income from prior years not previously distributed. This excise tax reinforces the distribution mandate even during years when technically meeting the ninety percent threshold.
REITs are classified by the nature of their real estate activities into three primary types — equity REITs, mortgage REITs, and hybrid REITs — each with a distinct risk and return profile that is tested on securities licensing examinations.
Equity REITs
Equity REITs own and operate income-producing real estate directly — office buildings, apartment complexes, shopping centres, industrial warehouses, data centres, cell towers, healthcare facilities, hotels, and other commercial properties. Revenue comes primarily from rents collected from tenants, with additional income from the appreciation and eventual sale of properties. Equity REITs are the most common REIT type, comprising the large majority of REIT market capitalisation in the United States, and they are the vehicle through which most retail investors access real estate ownership. The National Association of Real Estate Investment Trusts reports that as of 2024, equity REITs held approximately three point five trillion dollars in real estate assets across multiple property sectors.
Equity REIT dividends paid to individual investors qualify as ordinary income for tax purposes unless they represent return of capital or the distribution of previously taxed capital gains. Under the Tax Cuts and Jobs Act of 2017, non-corporate REIT shareholders may deduct up to twenty percent of qualified REIT dividends received as pass-through business income under IRC Section 199A, effectively reducing the top federal tax rate on ordinary REIT dividends from thirty-seven percent to twenty-nine point six percent.
Mortgage REITs
Mortgage REITs — also called mREITs — do not own real property directly but instead invest in real estate debt, primarily through the purchase of mortgage-backed securities and the origination or acquisition of mortgage loans. Their income comes from the interest earned on those mortgage instruments rather than from rental income. Mortgage REITs are highly sensitive to interest rate movements and to the spread between the short-term rates at which they borrow — typically in the repo market and through short-term debt instruments — and the longer-term rates at which they lend or invest. When interest rates rise rapidly or the yield curve inverts, mREIT net interest margins compress and their leverage-amplified balance sheets can produce severe earnings and book value deterioration. The Federal Housing Finance Agency, the SEC, and FINRA have all highlighted the complexity and interest rate sensitivity of mREITs as factors requiring careful suitability analysis before recommendation to retail investors.
Hybrid REITs
Hybrid REITs combine equity and mortgage REIT activities within a single entity — owning physical real estate while also holding mortgage loans and mortgage-backed securities. They are less common than either pure equity or pure mortgage REITs but provide diversification across both the ownership and the financing dimensions of the real estate market.
REITs are further classified by their trading status, and this classification carries significant implications for investor liquidity and suitability analysis.
Publicly traded REITs are listed on national securities exchanges — primarily NYSE and NASDAQ — and trade like stocks throughout the trading day at market prices that may differ from the underlying real estate net asset value. They are registered with the SEC under the Securities Exchange Act of 1934 and file periodic reports including Form 10-K and Form 10-Q. They are subject to full SEC disclosure requirements and are appropriate for a wide range of investors given their exchange liquidity.
Non-traded REITs are registered with the SEC and have the same REIT tax qualification as publicly traded REITs but do not list their shares on a national exchange. Shares are sold through broker-dealers during an offering period and are redeemable only through limited periodic redemption programmes at prices determined by periodic property appraisals. Non-traded REITs carry substantially higher liquidity risk than exchange-listed REITs and have been the subject of significant FINRA investor protection guidance. FINRA Rule 2310 governs the suitability requirements applicable to direct participation programme recommendations including non-traded REITs, and FINRA has issued multiple investor alerts warning that non-traded REITs carry high fees — historically six to fifteen percent of gross proceeds — limited liquidity, and periodic distribution payments that may include return of capital rather than genuine earnings.
Private REITs are exempt from SEC registration under Section 4(a)(2) of the Securities Act of 1933 or Regulation D and are available only to accredited investors or qualified institutional buyers. They offer no secondary market liquidity and are the least transparent of the three REIT categories.
REITs provide individual investors with three portfolio benefits that distinguish them from both direct real estate ownership and from conventional equity investments.
Diversification across real estate sectors allows REIT investors to achieve exposure to commercial real estate without the concentration risk of direct property ownership. A diversified REIT portfolio or a REIT index fund provides exposure to office, retail, industrial, residential, healthcare, infrastructure, and data centre properties simultaneously.
Income generation is the most commonly cited REIT benefit. The ninety percent mandatory distribution requirement under IRC Section 857 makes REITs among the highest-yielding publicly traded equity instruments available, with dividend yields that have historically exceeded those of the broad equity market. The combination of high current income and potential capital appreciation from property value growth makes REITs attractive to income-oriented investors.
Inflation linkage is a structural characteristic of equity REITs — commercial leases frequently contain annual rent escalation clauses tied to the Consumer Price Index or to fixed annual increases, providing a natural mechanism for rental income to rise with inflation over time. This inflation sensitivity makes equity REITs a partial inflation hedge within a diversified portfolio, complementing the inflation protection provided by Treasury Inflation-Protected Securities.
The correlation between REIT returns and broad equity market returns is meaningfully but not perfectly positive — REITs share the systemic risks of the equity market but also respond to real estate-specific supply and demand dynamics, interest rate movements, and economic cycle conditions that differ from the factors driving broad equity returns. This imperfect correlation provides genuine diversification benefit within a multi-asset portfolio.
REITs are tested on the SIE, Series 7, and Series 65 examinations in the context of investment products, real estate securities, pass-through tax treatment, qualification requirements, and suitability considerations for income-seeking investors.
The key points to retain are these.
A REIT is a corporation, trust, or association qualifying under IRC Section 856 for pass-through tax treatment on income distributed to shareholders. REIT qualification requires satisfying three tests annually — the asset test, the income test, and the distribution requirement. The seventy-five percent asset test under IRC Section 856(c)(4) requires that at least seventy-five percent of total assets be real estate assets, cash, and government securities at the close of each quarter. The seventy-five percent gross income test under IRC Section 856(c)(3) requires that at least seventy-five percent of gross income derive from qualifying real estate sources including rents, mortgage interest, and real property gains. The distribution requirement under IRC Section 857(a)(1) requires distribution of at least ninety percent of REIT taxable income annually — the dividends paid deduction eliminates corporate-level tax on distributed income. IRC Section 4981 imposes a four percent excise tax on underdistribution.
The three REIT types are equity REITs — owning physical real property and earning rental income; mortgage REITs — holding mortgage loans and mortgage-backed securities earning interest income with high interest rate sensitivity; and hybrid REITs combining both. The three trading categories are publicly traded REITs — listed on national exchanges, full SEC disclosure, highest liquidity; non-traded REITs — SEC-registered but unlisted, limited redemption, high fees, governed by FINRA Rule 2310 suitability requirements; and private REITs — unregistered under Securities Act Section 4(a)(2) or Regulation D, accredited investors only, no secondary market. Under IRC Section 199A and the Tax Cuts and Jobs Act of 2017, non-corporate shareholders may deduct up to twenty percent of qualified REIT dividends, reducing the effective top tax rate on ordinary REIT dividends to twenty-nine point six percent.
