The 90% REIT Distribution Requirement Explained

Introduction

The 90% distribution requirement is the operationally binding constraint of the REIT structure. To maintain REIT pass-through status, a REIT must distribute at least 90% of its annual taxable income to shareholders as dividends; any retained income above 10% gets taxed at the standard corporate rate (currently 21%). In practice, most REITs distribute at least 100% of taxable income each year to fully utilize the dividends-paid deduction and avoid any corporate-level tax. This single rule shapes most of what makes a REIT behave differently from an ordinary corporation: because retained earnings cannot fund growth, the REIT structure is structurally dependent on continuous capital markets access, it carries a dividend-driven shareholder base, and it leans on active tax planning around the timing and form of distributions.

The distribution requirement is also where REIT coverage work gets technical. It surfaces in M&A, where a target REIT must declare a final stub-period distribution to preserve REIT status through close; in equity issuance, where the proceeds change the taxable-income-versus-cash math; and in spin-offs and OPCo/PropCo separations, where the distribution mechanic has to be reconciled with the spin's own tax structure. The rest of this article works through the calculation, the menu of distribution mechanisms, and the penalties that bite when a REIT falls short.

The 90% test applies to REIT taxable income, defined under IRC Section 857, and it sits alongside the income and asset qualification tests a REIT must also clear each year. Crucially, the 90% figure is measured against taxable income computed without the dividends-paid deduction and without net capital gain, not against cash flow or FFO. Taxable income for distribution-test purposes:

REIT Dividends-Paid Deduction

The tax mechanism under IRC Section 561 that allows a REIT to deduct dividends paid to shareholders from its taxable income calculation, effectively eliminating entity-level corporate tax on distributed income. The dividends-paid deduction is the technical mechanism that implements the pass-through tax treatment of REITs; combined with the 90% distribution requirement, it produces the no-corporate-tax outcome on qualifying real estate income.

A REIT that distributes exactly 90% of its taxable income retains 10%, which is taxed at the 21% corporate rate. Most listed REITs distribute 100% to eliminate the entity-level tax entirely. Distributing above 100% (a "return of capital" distribution) is also common when REITs want to support a steady dividend per share while taxable income fluctuates with depreciation and one-time items; the excess distribution becomes a non-taxable return of basis to shareholders rather than a taxable dividend.

Why Most REITs Distribute 100% Instead of Just 90%

The economic difference between distributing 90% and 100% is the corporate tax on the 10% retained. For a REIT with $100 million of taxable income, distributing exactly 90% ($90 million) and retaining 10% ($10 million) generates $2.1 million of corporate tax on the retained $10M. Distributing 100% eliminates the $2.1M corporate tax but transfers the full $100 million to shareholders, who then pay their personal income tax on the additional $10 million of dividends. For most REITs, the 100% distribution approach is more tax-efficient because the dividends-paid deduction fully offsets entity-level tax, while the alternative leaves a 10% retained slice double-taxed (corporate tax of 21% then shareholder tax on any eventual distribution of that retained amount). That double-tax leakage is precisely the friction a REIT election exists to avoid, and it is the crux of any REIT-versus-C-corp comparison.

When analysts assess how much of its earnings a REIT actually pays out, they typically measure the dividend against FFO rather than against taxable income, since FFO is the standard cash-earnings proxy for the sector. The FFO-basis payout ratio expresses the per-share dividend as a fraction of FFO per share:

The key subtlety is that the 90% rule binds against taxable income, not FFO, and the two diverge sharply because taxable income is computed after depreciation while FFO adds depreciation back. Since FFO is usually much larger than taxable income, a REIT can satisfy the 90%-of-taxable-income mandate while paying out a far smaller share of FFO. That is why healthy REIT FFO payout ratios commonly sit in the 65% to 90% range rather than at or above 100%: the dividend that fully discharges the taxable-income requirement still leaves meaningful FFO retained as real cash, the same cushion the distribution test creates by running on a post-depreciation base.

REITs have several mechanisms available to satisfy the distribution requirement:

The Rev. Proc. 2017-45 Stock Dividend Mechanic

Revenue Procedure 2017-45, issued by the IRS in August 2017, created a safe harbor that allows publicly offered REITs to make stock distributions that qualify for the dividends-paid deduction, provided specific requirements are met. The key requirements:

The mechanism is economically valuable in cash-constrained periods because the REIT can distribute the full 100% of taxable income while only outlaying 20% in cash and issuing stock for the remaining 80%. Shareholders who elect cash receive the cash; shareholders who elect stock receive newly issued shares. The aggregate cash outflow is meaningfully reduced compared to a pure cash dividend, which lets the REIT preserve liquidity for acquisitions, debt service, or capex without sacrificing the distribution requirement.

Special Dividends

A REIT that discovers it under-distributed for a prior tax year has a remediation path through special dividends. The mechanic: the REIT declares the dividend by October 15 of the year following the under-distributed year (the extended Form 1120-REIT due date for a calendar-year REIT under IRC Section 858) and pays it by December 31 of that following year (within 12 months of the close of the under-distributed tax year). The shareholders pick up the dividend income in the year received, but the REIT can claim the dividends-paid deduction on the prior-year tax return. The mechanism preserves REIT status if a year-end calculation showed under-distribution.

Special dividends are also used for liquidating distributions when a REIT is winding down; the rules in that context include some additional flexibility around the deemed-distribution date.

Consent Dividends as Last-Resort Cure

The consent dividend is the most extreme cure mechanism. The REIT does not actually distribute cash or stock; instead, shareholders sign a consent form agreeing to report the deemed dividend amount as taxable income on their own returns. The REIT takes the corresponding dividends-paid deduction. Shareholders increase their basis in the REIT stock for the amount they reported.

REITs typically pay dividends on a quarterly schedule that aligns with the corporate-finance calendar: declaration in late month-1 of each quarter, ex-dividend date roughly mid-quarter, and payment in late month-3. The schedule provides shareholders with predictable income and lets the REIT spread the cash outflow across the year. A REIT that pays an even quarterly dividend totaling the prior-year's taxable income meets the 90% test on a continuous-distribution basis.

When acquisition activity, capital markets transactions, or capex programs create cash flow timing differences, REITs use mid-year special declarations to adjust the annual distribution total without disrupting the quarterly base. A REIT that completes a large acquisition late in the year, or books an outsized gain on a disposition, can discover that its regular quarterly distributions did not absorb all of its taxable income; an additional special distribution in the fourth quarter brings the annual total to or above 100%. This is why REITs sometimes announce a one-off "special" or "true-up" dividend in December.

Meeting the 90% test preserves REIT status, but it does not by itself avoid every entity-level tax. A separate provision (IRC Section 4981) imposes a 4% excise tax on the shortfall between what a REIT actually distributes during the calendar year and a "required distribution" amount. The required distribution is the sum of 85% of ordinary income, 95% of net capital gain income, and any undistributed amounts carried over from prior years.

The practical consequence is that a REIT has two different yardsticks running at once. The 90% test governs whether it keeps its REIT election; the 85/95 excise-tax test governs whether it owes a 4% penalty on the amount it held back. A REIT that distributes only its 90% minimum within the calendar year, deferring the rest, satisfies the qualification test but still writes a check for 4% of the gap to the required distribution. This is a large part of why so many REITs simply target 100%: clearing both yardsticks at once is administratively cleaner than fine-tuning two separate calculations.