What you need to do to form a REIT

Starting a REIT requires you to meet specific structural and operational rules set by the Internal Revenue Service. The basic path is: organize as a corporation or trust under your state's laws, register with the SEC if you will have more than 100 shareholders, file Form 1120-REIT with the IRS each year, and distribute at least 90 percent of your taxable income to shareholders as dividends. You will also need to own real estate or real estate debt, have at least 100 shareholders after the first year, and may support no single shareholder owns more than 50 percent of your shares.

The process takes several months from start to finish. You will work with a lawyer to draft your organizational documents, an accountant to set up tax reporting, and possibly an underwriter if you plan to raise money from public investors. The IRS does not pre-approve REITs — you structure your business to meet the rules, then report your status on your tax return. If you do not meet the requirements, you lose the tax benefits and pay corporate-level tax on your income.

Key Takeaways

  • You must organize as a corporation or trust, own real estate or real estate loans, and distribute at least 90 percent of taxable income to shareholders each year.
  • After your first year, you need at least 100 shareholders and no single shareholder can own more than 50 percent of your shares.
  • If you plan to raise money from the public, you must register with the SEC and follow securities rules for offering and selling shares.
  • A lawyer and accountant are essential — REIT rules are complex and mistakes cost you the tax status retroactively.
  • The IRS does not issue a REIT license; you file Form 1120-REIT each year to report your status and prove you meet the rules.

Choose your legal structure and state of organization

You can organize a REIT as either a corporation or a trust. Most REITs are corporations because the structure is simpler and more familiar to investors. A trust structure is less common but works the same way for tax purposes. You will file articles of incorporation or a trust agreement with your state — usually Delaware, Maryland, or your home state. The state filing itself does not make you a REIT; it just creates a legal entity. The REIT status comes from how you operate and what you report to the IRS.

Your organizational documents (bylaws or trust agreement) should spell out how you will distribute dividends, how shareholders vote, and how the board or trustees will manage the business. These documents do not have to mention the word "REIT," but they must allow you to follow the rules. A lawyer who knows REIT law will draft these to avoid traps — for example, language that accidentally prevents you from distributing enough income, or voting structures that violate the 50 percent ownership limit.

Acquire real estate or real estate debt

A REIT must own real property or loans secured by real property. You cannot be a REIT that only owns stocks, bonds, or other securities. Most REITs own apartment buildings, office buildings, shopping centers, warehouses, or hotels. Some own mortgages or construction loans instead. You need to own the real estate (or the debt) before you file your first REIT tax return, though you can start the legal entity first and buy property afterward.

The IRS requires that at least 75 percent of your total assets be real estate, real estate debt, or cash. The remaining 25 percent can be other investments, but the bulk of what you own must be real property. This rule prevents a REIT from being a general investment company that happens to own one building. If you drift below 75 percent real estate, you lose REIT status.

Set up your dividend distribution plan

A REIT must distribute at least 90 percent of its taxable income to shareholders each year. This is the core trade-off: you avoid corporate-level tax, but you cannot retain most of your earnings. You will need to decide how often to pay dividends — quarterly is standard — and set up a process to calculate how much each shareholder receives based on their ownership stake.

Your accountant will calculate your taxable income at year-end, determine the 90 percent threshold, and tell you how much you must distribute. If you do not distribute enough, the IRS will impose a penalty tax on the shortfall. Many REITs distribute more than 90 percent to stay safely above the minimum. You will also need to track which dividends are ordinary income, capital gains, or return of capital, because shareholders report these differently on their own tax returns.

Register with the SEC if you will raise money from the public

If you plan to sell shares to the public — meaning more than a small group of friends or family — you must register your REIT with the Securities and Exchange Commission. This involves filing a registration statement that describes your business, the real estate you own, your management team, and the risks investors face. The SEC reviews your filing and may ask questions before you can sell shares.

If you are raising money only from a small number of accredited investors (high-net-worth individuals or institutions), you may be able to use an exemption from full SEC registration, such as Regulation D. You will still need a lawyer to make sure your offering complies with securities law. Selling shares without proper registration is illegal and can result in fines and forced buybacks.

File Form 1120-REIT with the IRS each year

Every year, you file Form 1120-REIT (U.S. Income Tax Return for Real Estate Investment Trusts) with the IRS. This form reports your income, expenses, the dividends you paid, and confirms that you meet all the REIT rules. The IRS uses this return to verify that you own enough real estate, distributed enough income, and maintained the shareholder limits. If you fail any test, the IRS will disallow your REIT status, usually retroactively to the beginning of that year.

You must also send each shareholder a Form 1099-DIV showing the dividends they received and how much is ordinary income, capital gains, or return of capital. This is separate from the corporate tax return and is due to shareholders by January 31 each year. Missing this important date or filing incorrect amounts creates problems for your shareholders and can trigger IRS audits.

Maintain the shareholder and ownership rules

After your first year, you must have at least 100 shareholders. In your first year, you can have fewer, but by the end of year one you need to reach 100. No single shareholder can own more than 50 percent of your shares at any time. Additionally, at least 50 percent of your shares must be held by no more than five individuals (this prevents a handful of people from controlling the REIT). These rules exist to may support REITs are genuinely public investments, not private companies with a tax break.

If a shareholder tries to buy more than 50 percent of your shares, you must refuse the sale or redeem their excess shares. If you fall below 100 shareholders, you lose REIT status. These rules are strict and have no exceptions. You will need to track ownership carefully, especially if you have a shareholder who dies or transfers shares to a trust.

Work with a REIT lawyer and accountant from the start

REIT law is technical and mistakes are expensive. A lawyer who specializes in REITs will draft your organizational documents, review your property acquisitions to make sure they fit the REIT rules, and help you structure any debt or partnerships. An accountant will set up your tax accounting system, calculate your taxable income correctly, and file your annual return. Both should review your business plan before you start to flag any structural problems.

The cost of legal and accounting help is significant — typically $10,000 to $50,000 in the first year depending on the size and complexity of your REIT — but it is far cheaper than losing REIT status retroactively and owing back taxes plus penalties. Many REIT founders also hire an underwriter or placement agent if they are raising money from the public; this person helps market your shares and handles the mechanics of selling them.

Frequently Asked Questions

Can I start a REIT with just one property?

Yes, you can own a single property and be a REIT, as long as you meet all the other rules: at least 100 shareholders, proper dividend distribution, and SEC registration if you are raising money from the public. However, most single-property REITs are small and private, with a limited number of investors. A single property makes it harder to diversify risk, which is why most public REITs own multiple properties.

Do I need SEC registration to start a REIT?

Not if you are raising money only from a small group of accredited investors or family members. You still need to follow REIT tax rules and file Form 1120-REIT, but you can skip full SEC registration. However, if you want to sell shares to the general public or have more than a certain number of shareholders, SEC registration becomes necessary. A securities lawyer can tell you which path applies to your situation.

What happens if I do not distribute 90 percent of my income?

You lose your REIT status for that year and owe corporate-level tax on all your income, plus a penalty tax on the shortfall. The loss of REIT status is retroactive, meaning you cannot fix it by distributing the money later. You must calculate your taxable income carefully and distribute at least 90 percent by year-end to stay compliant.

How long does it take to form a REIT?

The legal and organizational steps typically take two to four months. State incorporation takes one to two weeks. SEC registration, if needed, can take several months of back-and-forth with regulators. You can start operating before SEC registration is complete, but you cannot sell shares to the public until it is approved.

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

Yes, but it requires careful planning. You will need to restructure your ownership, set up proper dividend distribution, and file an election with the IRS. An existing company with retained earnings or complex ownership may face tax complications during the conversion. A REIT lawyer and accountant should review your current structure before you attempt this.