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Why Congress Is Targeting These Dividend Favorites

Investors have flooded into high-yielding dividend stocks to get more income from their portfolios. But now, Congress is looking at potentially taking a bigger piece of the profits that popular high-yielding real estate investment trusts earn, as a Wall Street Journal report explains how the House Ways and Means Committee is looking at potentially revoking a big tax advantage that they've enjoyed for years. If Congress follows through, investors would likely be left paying the price.

Image source: Wikimedia Commons.

What are REITs?
Real estate investment trusts were almost unknown 15 years ago. But between the housing boom and the parallel rise in commercial real estate that largely continued until the 2008 financial crisis hit, REITs have attracted a substantial following among income-seeking investors.

The benefit that REITs enjoy over most companies is that REITs don't have to pay corporate taxes. Instead, they're required to pay at least 90% of their taxable income to their shareholders, who then have to pay individual income tax on what they receive. That may sound onerous, but the net result is to avoid the double taxation that most corporations face, paying tax at the corporate level and still leaving investors to pay taxes on their dividends.

Because of the requirement to pay out the vast majority of their income, REITs often have extremely high dividend payouts. Mortgage REITs ARMOUR Residential (NYSE: ARR  ) and Chimera Investment (NYSE: CIM  ) use leveraged strategies to produce yields well in excess of 10%, while Omega Healthcare (NYSE: OHI  ) and Senior Housing Properties Trust (NASDAQ: SNH  ) , which specialize in long-term care facilities and other properties catering to older residents, both have yields between 5% and 6%.

Why are REITs under fire?
Congress has been looking at a number of potential revenue-raising measures lately, so provisions that involve corporate tax breaks are a natural place to look. Moreover, many companies have been looking to take advantage of REIT status for all or a part of their operations, leading to concerns that the REIT format is being abused. Forest-products and timber giant Weyerhaeuser (NYSE: WY  ) converted itself to a REIT back in 2010, using its extensive timberland holdings as justification for the move. But recently, even casino operator Penn National Gaming has looked into putting its real-property holdings into a separate REIT as a possible tax-savings mechanism, with the company having gained the support of the Pennsylvania Gaming Control Board last week to take the step toward REIT status.

One reason REITs aren't in as much danger as other beneficiaries of tax breaks is that the revenue impact from revoking REIT status isn't as large as one might think. Currently, REIT investors pay ordinary tax rates on distributions, which can be as much as 20 percentage points higher than the rates that would apply to dividends if the favorable REIT tax status were revoked. The federal government would collect corporate taxes from the former REITs directly, but the net tax impact might not be all that large of a gain for the IRS.

Keep your eyes open
Nevertheless, as more companies look at REIT status, the odds of the tax break disappearing completely go up. For now, REIT investors should keep their eyes on Washington, understanding that if Congress passes a measure eliminating REITs' tax benefits, their dividend yields could potentially take a big hit.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 28, 2013, at 10:51 AM, Trumpace wrote:

    I realize Congress is loaded with a lot of folks that are dumber than a bucket of rocks but they at least have to understand that if they change the rules on REITS, the dividends will also change giving government less revenue in the end. So what will happen is a "steal from Peter to pay for Paul" event. If the rule is changed then the REITS will pay out less in dividends because the tax collected from them vs. the ones receiving the dividends would have a cause and effect event. There is little to gain from this unless they want to further piss off the elderly, the ones needing the income REIT's provide. Now before one thinks that the corporate tax collected is higher then the dividend tax collection, one should also consider the buying power, job creation the dividend receivers provide. How much of a loss to other tax collections those dividends provide for. This change in REIT rules is just plain and simple a dumb idea, most likely a far left idea. Politicians can not think past the nose on their face.

  • Report this Comment On May 01, 2013, at 7:45 PM, divnut wrote:

    It's a proven fact that Congress has been known to be a bunch of dummies, so why should we expect anything from them that makes sense. I say in order to save our country from financial problems, we should cut the pay of congress by 50%. They've never worked half as hard as the average american, but get the big bucks.

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