REIT Taxation – A Canadian Primer

dividends vs distributionReal Estate Income Trusts, or REITs for short, are companies that own or finance income-producing real estate. They receive special tax considerations and tend to have a higher distribution yield than corporations. Real estate assets can range from shopping malls, to apartment buildings, to office properties, or a mixed of the different assets. Due to the REIT structure and tax code, REIT taxation for investors in Canada differs from dividends and warrant a good understanding by individual investors. While REITs are meant to be tax-efficient businesses, their distributions is not a tax-efficient in the way that dividends are from corporations.

REIT Distributions

Before we dive into the tax impact of holding a REIT in a non-registered account, you need to understand the difference between dividends and distributions. If you look at the information provided on a REIT website such as RioCan, you can see that they mention distribution and not dividend. It simply means that the company’s distribution to investors is not considered an eligible dividend from a tax perspective.

In fact, dividends are reported on a T5 form while distributions are reported on a T3 form (see below). It is possible to receive some dividends from a REIT and if so, it will be included as one of the source of income and also be reported on the T3 with the gross up information needed.

RioCan (TSE:REI.UN) clearly outlines the ratios of the following income sources on their site. As you can see, there can be up to 6 different sources below.

RioCan - Distribution Breakdown
Source: RioCan Investor Relations

In a tax-free account, such as TFSA, RRSP/RRIF or RESP, holding a REIT investment is not a concern since you don’t have to pay any taxes but in a non-registered account, it has an implication and considerations. Not only because you declare the distribution as income on your taxes but because there can also be a return of capital (ROC) and that impacts your accounting. Note that ROC from REITs is the most tax efficient payout as the distribution is converted into a potential capital gains to be paid later at the time of disposition.

When choosing the best Canadian REIT, if you plan on holding it in a non-registered account, you need to compare the net income from the REIT you have in mind with a good high yield stock such as BCE (TSE:BCE, NYSE:BCE). The tax impact can make both investments be the same in the end.

Dividends vs Distribution: What’s the difference?

REIT Taxation (in Canada)

Income tax on REITs is actually pretty simple to understand, however the tracking of the details year after year is where the challenge is. The reduction in adjusted cost base (ACB) is what creates a tracking challenge. In the RioCan example above, you can see a pretty large ratio of return of capital (ROC – another name for the adjusted ACB) and that changes the cost of your investment. You need to adjust the cost of your holdings every time you receive the T3. You therefore need to be diligent with your tracking as you will have to report capital gains at a later time. It’s even possible that the cost of the share ends up at $0 if you hold the REIT for long enough.

It’s important to note that none of the tax considerations below apply when you hold REIT investments in a tax-sheltered account. You may also need to consider that withdrawal from a RRSP are treated as income and your marginal tax rate will apply.

REIT Tax Details

Other Income: This amount represents the revenue you are getting from the REIT as part of their operating business. Think of this income as the rental revenue from the holdings. This income is taxed at your marginal tax rate just like interest would be taxed.

Capital Gains: The capital gains reported is taxed at half your marginal tax rate. It is also said that you are taxed on 50% of the capital gains at your marginal tax rate.

Foreign Non-Business Income: When a REIT holds US or foreign properties, the foreign revenue is reported as Foreign Non-Business Income and is taxed at your marginal tax rate. It usually represents the rental income from the foreign holdings.

Return of Capital: This amount is the company giving you your money back. There is no immediate tax to pay on it as it simply reduces the cost of the share. It requires a good stock tracking system. ROC is referred to as a reduction in adjusted cost base (or ACB). For example, if you paid a REIT share $10 and the REIT has a ROC of $0.50 per share, your new cost is $9.50 per shares. As you can see in the RioCan distribution above, the ROC ratio of a distribution can be significant.

This is the reason why I don’t hold REITs in a non-registered account. The tracking is a lot of work even though I am well setup to track my investment portfolio.

Portfolio & Dividend Tracker

Dividend & Distribution Tax Summary

Image courtesy of cooldesign – FreeDigitalPhotos.net

20 Responses to "REIT Taxation – A Canadian Primer"

  1. There is good ROC and bad ROC.
    With REIT’s .. it’s usually the very good kind and provides several tax advantages to the Investor.
    1) The taxation is deferred until the units are sold. You can effectively defer taxation for years.
    2) When taxed, it’s at the 50% Captial gains rate. Compared to the 100% full tax rate if you kept it in a RRSP.

    Good ROC means they are not just ‘returning your capital’. For example, REITs depreciate their assets for accounting purposes, which reduces net income. The difference is classified as ROC and is included in the distribution to unitholders.

    Yes ..it is a pain to calculate the ACB. But this can be automated. Simple spreadsheet or other tool.
    Personally, I avoid putting REIT or Dividend stocks in an RRSP. RRSP withdrawals are taxed at the highest rate possible.
    Whereas Dividend/ROC are taxed at much much much lower rates.

    See http://www.jamiegolombek.com/articledetail.php?article_id=816
    And the end of this link http://www.theglobeandmail.com/globe-investor/investor-education/learning-to-roll-with-roc-can-pay-off/article24704378/

    Reply
    1. @Wes
      Thanks for the detailed comment. Much appreciated. Just to put your comment into perspective, are you retired, near retirement, or starting? I find that comments often are based on the person’s situation

      ROC is definitely an important consideration as it changes the tax rate from income to capital gains. It does require tracking and be diligent which is not always the case when investors start investing.

      I would also argue that the account to put an investment such as RRSP and TFSA due to taxes paid later is a whole other debate where I have not seen any conclusive winning side yet. The current thoughts is that you should use your TFSA first and then move your money in a RRSP once you are in a higher tax bracket so that you can put more of your money at work. If you just use the refund to travel the world, you obviously missed the point …

      From my early investing days I have been debating adding to my RRSP over just using non-registered based on a future tax break. It’s just not possible to ignore RRSP with matching programs from employers and the immediate tax break to put your money at work. If you can have the extra money make more money, it can offset the marginal tax rate of RRSP withdrawal in the long term. Then you can invest it wisely in a tax efficient manner.

      Question for you, why do you avoid putting a dividend stock in a RRSP? If it goes to double or triple over 30 years, what’s the difference if it pays dividend? Are you saying you buy bonds? How do you approach total return? or are you retired?

      Reply
      1. Yes, certainly employer match and re-investing the big RRSP refund are good arguments for using an RRSP.
        Provided you re-invest it of course.

        At the end of the day.. it’s not how much you make. It’s how much you keep after taxes. .
        The RRSP effectively converts a low tax investment such a Capital Gains, Distributions,Dividends into a very high tax instrument.

        I’m approaching Retirement and am looking for the most tax efficient way to spend my life savings.
        My TFSA is maxed and my RRSP/LIRA is static.
        New money is going into REITs and other dividend stocks in my taxable account.

        My point about ROC was that it’s a huge tax benefit for anyone using a taxable account.
        Taxes are deferred and then only taxed at the 50% cap gains rate.
        Makes the annual accounting well worthwhile.

  2. Kudos on another great and timely article.

    I would like to offer readers though, a counter point to consider. While the tracking of the adjusted ACB might be difficult (many brokers adjust the ACB on your statements after the T3 slips are posted), it is still far tax-advantageous to be holding these type of investments outside of the RRSP/RRIF. Dividend & capital gain tax rates are superior to RRSP tax rates.

    That said, the best place for these investments are currently TFSA (assuming you’re not a US citizen and no foreign investments). No taxes to pay on distributions – regardless of the characterization of the distribution – and no headache to track the ROC.

    Happy investing everyone!

    Reply
  3. @Raphael
    Thanks for the comment. There is another comment on RRSP tax rate on withdrawal which has me curious. Can you specify if you are retired? or near retirement? I am curious how the RRSP tax rate come into play when building a portfolio at different point in life.

    For example, does that matter in a RRSP when building wealth and focusing on growth. You might still want REITs to diversify. At the end of the day, I don’t think it matters how the money in a RRSP grew, it all ends up being taxed the same way on withdrawal. What matters is that it made a lot of money.

    On a diversification perspective, does one portfolio look like TFSA holds REITs mostly and other accounts hold other investments? Is that how you are approaching it? and is that because of the income you need in retirement?

    I am still in the accumulation phase and can’t share much on the retirement strategy other than theories so I would be happy to hear more.

    Reply
    1. I am 33 and my income only in the past 2-3 years has appreciated to the point where I am comfortable accumulating it without the worry of immediate use. So I am really just beginning my investment journey. I’ve dabbled in investing for about 5-6 years, but nothing meaningful until more recently.

      To discuss your points, IMHO, there’s three primary types of diversification. One of the type of investment (i.e. stock, REIT, Bond, ETF, Mutual fund), one of the segment or industry or country, and the 3rd is of the account to invest it in.
      Typical investors will strategize their diversification within an account, but truthfully, it needs to be done over the global investment portfolio and not just within each account. Which is why I enjoy the dividend tracker spreadsheet you’ve created.
      Again, IMHO, entities that provide T3 slips (ETFs, mutual funds and REITs) are best suited for the TFSA. Bond or bond ETF investments or foreign investments are best held in RRSP/RRIF accounts, and finally vanilla stocks or other entities that pay out dividends I put everywhere – non-taxable, TFSA and RRSP.

      While it is true that the RRSP account converts capital gains & dividends into regular income and taxed at your current tax rate at the time of withdrawal (which may be the higher rates); however that should not stop people from investing in there altogether, because the 2nd benefit of such an account is the tax-free growth until the time of withdrawal. And the bite from a taxable account all along the way could potentially be significant.

      Also, there used to be more of a debate when the TFSA first began and was small. But now, we’re about 8 years or something since it began and the maximum that can be contributed is something like $50,000. So at this point, it can really be used well – and IMHO the first place to invest. BIG CAVEAT – not for US citizens or foreign investments.

      Reply
  4. Awesome article (as usual).
    I started dividend investing for an income around the same time as you did (2009), I also have a mix of non-registered, TFSA and RRSP as you do in your portfolio. I have had non-registered REITs since the beginning. My experience with tracking these:
    1) I use a spreadsheet to track my non-registered stock dividend payouts which automatically calculates ACB. The additional input/calculation added to the spreadsheet for REITS is the ability to enter the T3 Box 42 amount each year and adjustment of ACB. 3rd post at this link explains the calculation: http://canadianmoneyforum.com/archive/index.php/t-11412.html
    2) I don’t find any additional burden associated with doing my taxes between entering T3 for REITs versus a T5.
    3) The part that can be frustrating, if you want to submit your taxes “early”, is T5 don’t have to get mailed out until March 31 as explained here:
    http://www.theglobeandmail.com/globe-investor/investor-education/dont-be-worried-yet-about-tardy-t3s/article23669943/
    Hope this is helpful.

    Reply
  5. @Wes & others,

    I’ve been hearing rumblings that the Liberal government will be proposing in the upcoming Budget that capital gains be taxed at 75% instead of 50%… there goes that preferential treatment.

    Reply
    1. @Raphael
      That would still beat the tax on a RRSP withdrawal. It is disappointing but would that change the strategy? Both you and Wes have me reconsidering holding REITs in a taxable account and suck up the accounting.

      Reply
      1. As with everything. Yes and no.
        While the withdrawal is 100% taxable from a RRSP (versus 50% taxable regular), however the zero-tax growth throughout the accumulation phase of your life may allow the total portfolio to grow and surpass that in a taxable account.

        For example, and this is completely hypothetical, if one was to own stocks in a taxable account, buy and sell, pay taxes, etc etc until retirement (lets call it age 50 (isn’t that the dream?), the final portfolio value may be X amount.
        But in an RRSP, it is conceptually possible that owning the same portfolio in the RRSP, buying & selling, topping it up with the tax savings on the RRSP deductions – or even leaving out the tax savings – paying no taxes for years, etc etc and letting the portfolio grow… Theoretically, pulling out the full portfolio at the same age 50, paying the taxes on the full 100%… you can be ahead. It would depend on how much tax you paid throughout the years on the dividends, interest and capital gains, because investing in an RRSP allows for a larger pool of capital to be invested.

        Even a hardline Buy and Hold investor may not come out ahead if the tax leakage from the dividends amounts to a significant enough portion that the growth on this leakage would allow the RRSP path to surpass the taxable account path.

        But in a vacuum, yes, capital gains that are 50% taxable versus 100% taxable are better.

  6. Hi, there, i am still confused after reading your article and hopefully someone can help me out. I hold D.UN in my cash account which is a stupid idea and now i have to claim tax return. I am not sure how to calculate my capital gain:

    In 2015,bought 600×26.27/share;

    2015 Tax Year: (T3)
    21 – 165.02
    26 – 325.70
    42 – 666.39

    In 2016, sold 668X20/share;(sold them all and 68 more units were DRIP reinvested)(T3)
    21 – 237.29
    26 – 130.70
    42 – 2.71

    I was thining about claiming 600X26.27 plus commission as the cost; 668X20 plus COMMISSION as the redemption. After checking CRA site and ACB drew my attention and I googled and found your site.

    I am wondering if my capital gain should be calculated as:
    600X26.27+ commission + 165.02 + 325.70 + 237.29 + 130.70 – 666.39 (ROC) – 2.71(ROC)?

    thanks everyone in advance.

    Reply
      1. Thanks, Dividend Earner. So you suggest I use the raw data from the broker, don’t use T3 numbers? Or use the raw data to calculation the distribution, because I didn’t receive T5, which means all were distribution, and then minus ROC? Thanks again for your help!

      2. @Richard
        You should use the T3 form but you need to use it against your purchase prices and you are dealing with multiple years and possibly multiple number of shares.

        The easiest way is to setup a spreadsheet to track it or bring your documents to an accountant. I think the H&R block setups charge a little extra to do investments but you will need all the share purchases and DRIP purchases to calculate the proper capital gains due to ROC.

    1. @Richard
      Couple of suggestions:
      1) At top, right-hand side of this website you will find, under Must Read section: Track your Dividends like a Pro
      2) Drip Primer website also has an explanation and spreadsheet: http://www.dripprimer.ca/calculate-acb
      Note my comment (point 1) above about box 42 for REITs and how it impacts ACB, any spreadsheet you use should allow you to enter this amount and do the adjustment.
      As Dividend Earner indicated, If you are uncomfortable with DIY, it might be easier to get an accountant to do it.

      Reply
  7. Thanks for all the suggestions, it is really painful to check all the details. I will go ahead with

    ACB: (600X26.27 + commission – ROC – Paidout cash (leftover from DRIP)) / 668

    (600X26.27+commission is exactly how much I paid to eventually get that 668 through DRIP. some leftover cash was paid to me directly, which I will also deduct from the cost)

    My idea is that basically because I sold all of them, I don’t need to worry how much I paid for the units through DRIP, I only need to calculate how much i spent and minus how much I sold. ROC means i was being taxed at a later date, so i need to put it in.

    Any suggestion?

    Reply
    1. @Richard
      The DRIP shares actually have a cost for capital gains. If you don’t include them, you are over paying your taxes. Basically, you paid taxes on the dividends that was used to purchased the DRIP shares, not including the cost of those shares means you are paying taxes on the dividend twice.

      Reply
  8. Thanks a lot dividend Earner. Sorry to bother you guys so much. My REITs situation is a bit complicated and i was losing money so I don’t want to spend money to hire an accountant unless I have no choice.

    Like you suggested, i started to use spreadsheet, however for the dividend besides reinvested in some units of REITs, i have some leftover cash, and I don’t know how to calculate the cash part.

    Fort instance,
    I had 100 units of one REIT, i bought it 100 X 8(per share), plus commission of 10 dollars, my ACB is 100 X 8+10 = 810
    then came the dividend, 0.1 dollars per share, so the dividend is 10 dollars, with this 10 dollars, 9 was used to buy 1 share and 1 dollars left in the balance. How do i calculate the ACB now? it would be easy if all of the dividend goes to buy share.

    Also in my T3, for that dividend of 10 dollars, they broke it down to 3 (21), 5(26) and 2 (42 also meant ROC). I just got so confused with all these number. If any of you can tell me how the cash goes, and how to use ROC in T3, I would be much appreciated.

    Reply
  9. I finally figured out how to calculate ACB, and this is the result. Thanks everyone and if i am wrong, please correct me.

    Now i know how to calculate my ACB, so my scenario above is:

    New ACB is: 100 X 8 + commission + 9 – 2

    If commission is 10 dollars, the total is: 810+9-2= 817. And my ACB per share is 817/11= 74.27

    Reply

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