Creating a REIT requires meeting strict legal and structural rules set by the IRS and the Securities and Exchange Commission

A REIT is a corporation, trust, or association that owns and operates income-producing real estate. To create one, you must first decide whether you want a publicly traded REIT (listed on a stock exchange), a publicly offered REIT (sold to the public but not exchange-listed), or a private REIT (sold only to accredited investors). Each path has different regulatory demands, filing requirements, and costs.

The basic process involves forming a legal entity in your state, acquiring real estate or real estate debt, structuring the ownership to meet IRS requirements, filing with the SEC if you plan to raise capital from the public, and then maintaining compliance with REIT rules every year. The entire process typically takes several months to over a year, depending on the type of REIT and the complexity of your real estate holdings.

Key Takeaways

  • You must form a legal entity (usually a corporation or trust) in your state and then register with the SEC if you plan to offer shares to the public.
  • A REIT must own real estate or real estate debt, distribute at least 90 percent of taxable income to shareholders annually, and meet specific asset and income tests each year.
  • Private REITs avoid SEC registration but can only sell to accredited investors and face fewer disclosure rules; public REITs must file detailed financial statements quarterly and annually.
  • You will need to hire a securities attorney, a tax advisor familiar with REIT rules, and likely an accountant to handle ongoing compliance and annual testing.
  • The IRS requires you to file Form 1120-REIT each year to report income, deductions, and distributions, and to prove you meet all REIT qualification tests.

Choosing Between Public, Publicly Offered, and Private REIT Structures

A publicly traded REIT lists its shares on a national stock exchange such as the New York Stock Exchange or NASDAQ. This structure requires full SEC registration under the Securities Act of 1933, ongoing quarterly and annual reporting, and compliance with stock exchange listing standards. The upside is access to capital markets and liquidity for shareholders. The downside is substantial regulatory cost and disclosure burden from day one.

A publicly offered REIT sells shares to the public but does not list on an exchange. It still requires SEC registration and ongoing reporting, though the rules are somewhat less stringent than for exchange-listed REITs. These are often sold through broker-dealers and marketed to retail investors.

A private REIT sells shares only to accredited investors (generally those with a net worth above $1 million or annual income above $200,000). Private REITs do not file with the SEC and have far fewer disclosure requirements, making them cheaper to launch and operate. However, they cannot raise capital as easily and offer no public market for shareholders to sell their shares.

Forming Your Legal Entity and Acquiring Real Estate

You must first form a legal entity—typically a corporation or a trust—in your state of choice. Most REITs are organized as corporations because the structure is familiar to investors and tax advisors. You will file articles of incorporation with your state's secretary of state and pay the associated filing fees, which vary by state but typically range from $100 to $500.

Once your entity exists, you acquire real estate or real estate debt. The REIT must own the properties or debt instruments directly; it cannot own them through subsidiaries (with limited exceptions). The types of real estate that may have access to include apartment buildings, office buildings, shopping centers, hotels, industrial warehouses, and mortgages on real property. You do not have to own all the properties yourself—you can acquire them gradually or through a merger with an existing real estate company.

The real estate must generate income. A REIT cannot own raw land held for speculation, and it cannot operate the properties as a hotel or manage them as a business (with narrow exceptions). Instead, it collects rent, mortgage interest, or other real estate-related income and passes that income to shareholders.

Meeting the IRS Tests for REIT Status

The IRS imposes several tests that your REIT must pass every year to keep its status. These tests are not one-time hurdles—you must satisfy them annually and report your compliance on Form 1120-REIT.

The income test requires that at least 75 percent of your gross income come from real estate sources: rents, mortgage interest, gains from the sale of real property, and certain other real estate-related income. The remaining 25 percent can come from other sources, but there are limits on how much can come from certain types of income like interest on non-mortgage debt.

The asset test requires that at least 75 percent of your total assets be invested in real estate, mortgages, and cash. The remaining 25 percent can be in other investments, but you cannot hold more than 10 percent of the outstanding securities of any one company (with exceptions for other REITs and certain government securities).

The distribution test requires that you distribute at least 90 percent of your taxable income to shareholders each year. This distribution is mandatory—you cannot retain earnings the way a regular corporation can. The distributions must be made in cash or other property, and shareholders receive a Form 1099-DIV reporting the distributions.

You must also have at least 100 shareholders and may support that no more than 50 percent of your shares are owned by five or fewer individuals at any time during the year. These tests prevent a REIT from being a vehicle for a single investor or a small group.

SEC Registration and Offering Documents for Public and Publicly Offered REITs

If you plan to offer shares to the public, you must register with the SEC. For a publicly traded REIT, you file a Form S-1 (or Form S-11, which is specific to real estate companies) with the SEC. This document includes detailed information about your company, the real estate you own, management, financial statements, risk factors, and the terms of the shares you are offering.

The SEC review process typically takes several months. You will submit your filing, receive comments from SEC staff, revise your filing, and repeat until the SEC declares your registration statement effective. During this time, you cannot sell shares to the public, though you can solicit interest from potential investors.

For a publicly offered REIT not listed on an exchange, the registration process is similar but may use Form S-1 or Regulation A (for smaller offerings). The SEC still reviews your disclosures, but the process may be faster and less expensive than for exchange-listed REITs.

Once registered, you must file quarterly reports (Form 10-Q) and annual reports (Form 10-K) with the SEC, hold annual shareholder meetings, and comply with proxy rules if you solicit shareholder votes. These ongoing obligations require a dedicated investor relations team or outside advisors.

Ongoing Compliance and Annual REIT Testing

After you launch your REIT, you must file Form 1120-REIT with the IRS each year by the 15th day of the ninth month after the end of your tax year (typically September 15 for calendar-year REITs). This form reports your income, deductions, distributions to shareholders, and your compliance with the income, asset, and distribution tests.

You must also maintain detailed records of your real estate holdings, income sources, shareholder ownership, and distributions. If you fail any of the REIT tests, you lose REIT status for that year and the following year, and your income is taxed at the corporate level instead of flowing through to shareholders.

If you are a public or publicly offered REIT, you file quarterly and annual reports with the SEC, hold shareholder meetings, and comply with securities laws regarding insider trading, proxy statements, and disclosure of material events. Private REITs have fewer reporting requirements but still must maintain records and file Form 1120-REIT.

Many REITs hire a compliance officer or work with outside counsel to monitor these requirements throughout the year. The cost of compliance is substantial—legal fees, accounting fees, and audit costs can easily exceed $100,000 annually for a small REIT and millions for a large public REIT.

Hiring Professional Advisors and Understanding Costs

Creating and operating a REIT requires informed in securities law, tax law, real estate law, and accounting. You will need to hire a securities attorney to draft your organizational documents, prepare SEC filings (if applicable), and advise on compliance. A tax advisor with REIT experience is essential to structure your entity correctly and may support you meet the annual tests. An accountant will handle bookkeeping, financial reporting, and Form 1120-REIT preparation.

The cost of launching a REIT varies widely. A private REIT with a small number of investors might cost $50,000 to $150,000 in legal and accounting fees. A publicly offered REIT can cost $200,000 to $500,000 or more. A publicly traded REIT can cost $1 million to $5 million or more, including SEC registration, underwriting fees, and initial compliance setup.

These are one-time costs. Ongoing annual compliance costs for a private REIT might be $20,000 to $50,000 per year. For a public REIT, annual compliance costs can exceed $500,000 to $1 million, depending on size and complexity.

Frequently Asked Questions

Can I convert an existing real estate company into a REIT?

Yes. You can merge your existing company into a newly formed REIT or restructure your company to become a REIT. The process involves ensuring your assets and income meet the REIT tests, obtaining shareholder approval if required, and filing the appropriate documents with the IRS and SEC. A tax attorney can advise on the best structure to minimize tax consequences.

What happens if my REIT fails one of the IRS tests in a given year?

If you fail an income or asset test, you lose REIT status for that year and the following year. Your income is then taxed at the corporate level, and you must pay corporate income tax before distributing to shareholders. You may be able to regain REIT status in the third year if you come back into compliance, but the tax consequences can be severe. Some failures can be cured if you take corrective action within a specified time frame.

Do I need to own the real estate outright, or can I use debt to finance it?

You can use debt to finance real estate acquisitions. In fact, most REITs use substantial leverage. However, the debt must be secured by the real property, and the interest you pay on that debt counts toward your income test. Debt that is not secured by real property (such as corporate bonds) generates income that does not count toward the 75 percent real estate income threshold, so you must be careful about your financing structure.

Can a REIT own and operate a hotel or apartment building directly?

A REIT can own the building but generally cannot operate it. If you operate the property yourself, the income may not may have access to as real estate income under IRS rules. Instead, most REITs lease the property to an independent operator (called a triple-net lease) or hire a third-party management company. The REIT collects rent or management fees, which count as real estate income.

How do shareholders receive distributions from a REIT?

Shareholders receive distributions in cash, usually quarterly. The REIT calculates the amount based on taxable income and the number of shares outstanding. Shareholders receive a Form 1099-DIV reporting the distributions, which they must include on their tax return. Distributions are taxed as ordinary income to the shareholder, not as capital gains (unless the REIT sells property at a gain and designates part of the distribution as a capital gain).