On a recent episode of our Industry Focus show, Fool.com contributor Matt Frankel, a Certified Financial Planner, answered a listener question: Are Roth IRAs the best place to hold real estate investment trusts, or REITs? In this video clip from the show's August 16 Fool Live recording, hear what Matt and host Jason Moser had to say.
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Matt Frankel: Basically, the big tax advantage to REITs is that they don't pay any corporate tax. Most companies like let's say you own Apple (AAPL 4.86%) stock, your dividends are effectively taxed twice. When Apple earns a profit, they are taxed at the corporate level. Then when they pay that out to individuals, those dividends are taxed again as income. Double taxation of dividends. REITs avoids that by essentially being treated as pass-through businesses, same as if you owned your own business. Because of that, they don't get the IRS' qualified dividend treatment, which is better tax rates than you would pay on ordinary income. REIT dividends are generally treated as income you got from work. They qualify generally for the 20% pass-through tax deduction but that gets a little complicated. They don't get the same tax advantages that normal dividends do in other words. If you own them in an IRA, whether a traditional or Roth, you avoid the individual tax, and don't pay any tax on until you sell in a traditional IRA or ever in a Roth IRA. If a Roth IRA makes sense for you, generally, a Roth IRA makes sense for people who are in a lower tax bracket now than they think they will be in retirement. For that reason, Roths often makes sense for people early on in their careers as a great rule of thumb. Your first few years of work, Roth IRAs make a lot of sense. Beyond that, you need to assess where you think you're going to be at retirement and see which one makes better sense for you. If a Roth IRA is the better of the two IRAs for you, REITs make a ton of sense in IRAs. I have a Roth IRA that I contributed to for a while. It's full of REITs. That should answer the question right there. Most of my REIT holdings are in retirement accounts, whether it'd be an IRA or a solo 401(k), which is what I use right now. But they're great retirement investments because of their unique tax advantage, you essentially get to avoid taxes forever on REITs.
Jason Moser: I like the sound of that; avoid taxes forever.