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Ask Millionacres: I Bought REITs With a Roth. What Are My Tax Consequences?

[Updated: Jan 28, 2021 ] Feb 25, 2020 by Matt Frankel, CFP
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Q: I have bought some REIT stocks in my Roth account. What are the tax consequences for them? — Cokie

The short answer is that there probably are no tax consequences of owning real estate investment trusts (REITs) in a Roth IRA.

For a little more color, Roth IRAs are funded with after-tax dollars. This means that you can't deduct your contributions in the tax year they were made, unlike with a traditional IRA or 401k. However, qualifying withdrawals will be 100% tax-free. This is true regardless of how much your investments have increased in value, how much dividend income you've received in your account, or whether your Roth IRA holds investments with complex dividend tax structures (like REITs).

I say "probably" because there are some circumstances where a Roth IRA may be taxable.

Before we go further, it's important to understand the Roth IRA withdrawal rules. You can withdraw your original Roth contributions at any time, without penalty. After all, you've already paid taxes on the money you put into a Roth IRA, so the IRS doesn't really care what you do with it.

On the other hand, when it comes to withdrawing investment earnings from a Roth IRA, you must meet both of the following two criteria:

  • You must be at least 59 ½ years old.
  • Your Roth IRA must have been open for at least five years to avoid taxes and penalties.

If either of these time-related rules doesn't apply, your withdrawals of investment earnings can be subject to income taxes as well as a 10% IRS penalty.

So, if you buy your REITs in a Roth IRA when you're 35 and cash out your account when you're 50, the portion of the account that represents profit can be subject to tax, unless you qualify for an exemption (like paying for your kids' college tuition).

However, as long as you meet the age requirement and five-year rule, there will be no tax implications whatsoever of owning REITs in your Roth IRA. In fact, I've written before that REITs are one of the best possible investments you can make in a Roth IRA. Not only do most REITs pay above-average dividends and have strong total return potential, but REITs are one of the only types of U.S. stocks whose dividends generally don't get the favorable "qualified dividend" tax treatment.

REITs can be an especially great investment in a Roth IRA if you're in a relatively low tax bracket, as you can "lock in" your current tax rate on your contributions and pay no further capital gains, dividend, or income taxes on your REITs -- ever. However, if you're in a high tax bracket, a traditional IRA or other type of tax-deferred retirement account could be the best choice for your REIT investments.

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