Learn › REIT Basics · 7 min read

REIT Qualification Rules (Asset & Income Tests)

REITs must pass annual IRS tests covering how they are organized, where income comes from, what assets they hold, and payouts

Four categories of rules

The REIT qualification rules are the specific requirements a company must satisfy every year to be taxed as a REIT rather than as an ordinary corporation. They fall into four broad categories:

• How the company is organized
• Where its income comes from
• What kinds of assets it holds
• How much income it distributes to shareholders

All four have to be met — meeting three out of four is not enough. For the broader picture of what a REIT is and how it operates day to day, see What Is a REIT? and How REITs Work.

Organizational requirements

A REIT must be organized as a corporation, trust, or association that would otherwise be taxable as a corporation, and it must be managed by a board of directors or trustees. Its shares have to be fully transferable, and it needs at least 100 shareholders, a threshold it generally has to meet by its second year of existence.

There is also a concentration limit known informally as the "5/50 rule": no five or fewer individuals can own more than 50% of the value of a REIT's shares during the last half of the tax year. The point of both rules is the same — a REIT is meant to be a broadly held vehicle for many investors, not a closely held company for a handful of owners wrapped in a tax-favored structure. These rules trace back to the original purpose of the REIT structure: giving a broad base of ordinary investors, not just a small group of insiders, access to institutional-quality real estate.

The income tests

REITs face two gross income tests, both measured annually. At least 75% of gross income must come from real estate sources: rents from real property, interest on mortgages secured by real property, gains from selling real estate, and a few related categories. At least 95% of gross income must come from that same list of real estate sources plus other largely passive income, such as dividends and interest generally.

Together, these tests keep a REIT's business genuinely focused on real estate. A company that earned most of its money from, say, an unrelated manufacturing operation would not pass. Rents from real property generally have to meet their own conditions too — for example, rent generally cannot be tied to the tenant's net income the way a profit-sharing arrangement would be, which keeps the REIT's role closer to that of a landlord than a business partner.

The asset tests

On the balance sheet side, at least 75% of a REIT's total assets must consist of real estate, cash and cash items, and government securities. There are also diversification limits on the remaining assets — a REIT generally cannot hold an outsized position in the securities of any single non-real-estate issuer, which keeps it from operating like a general investment fund picking stocks. These asset limits work alongside the income tests to keep a REIT's balance sheet, not just its revenue, anchored in real estate rather than in an unrelated investment portfolio.

REITs are permitted to own taxable REIT subsidiaries (TRS), separate corporations that can provide services to tenants or engage in activities that would not otherwise qualify under the income tests, subject to their own limits on how large they can be relative to the REIT's total assets. This gives REITs some flexibility, for example to offer services at a hotel or senior living property, without disqualifying the parent company.

The distribution test

Finally, a REIT has to distribute at least 90% of its taxable income to shareholders every year. This is significant enough to warrant its own explanation — see The 90% Distribution Rule for the full picture, including why the number matters and what counts toward it.

What happens if a REIT falls short

The tax code includes certain relief and cure provisions that allow a REIT to correct some testing failures, often by paying a penalty tax and fixing the underlying issue, without automatically losing REIT status over an isolated or inadvertent mistake. Repeated or willful failures are a different matter and can result in losing REIT status, which would make the company's income taxable at the corporate level going forward. In practice, established public REITs devote significant compliance effort to monitoring these tests continuously, precisely because the consequences of failing them are so significant. Public REITs typically employ dedicated tax and compliance staff, and many retain outside tax counsel, specifically to test these thresholds throughout the year rather than discovering a problem only when filing an annual return. See REIT Compliance & Regulation for more on how this oversight works.

Why these rules matter to investors

For anyone researching REITs, the qualification rules are useful context rather than trivia: they explain why REITs concentrate on real estate, why they pay out so much income, and why their ownership tends to be broad rather than concentrated in a few hands. They also explain why a REIT's quarterly and annual filings, available through the SEC and often summarized on this site's profile pages, devote real space to confirming the company still meets each test.

You can browse companies that meet these standards on the REIT screener, and look up related terms, like taxable REIT subsidiary or gross income test, in the glossary.

See it in the data: Screen REITs by the numbers →

Research and education only — nothing here is investment advice. Figures such as the 90% distribution rule are general and can change; always confirm against a company's filings.