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Return of Capital Distributions

Part of many REIT distributions isn't taxed as income at all — it's classified as a return of your own invested capital

What "return of capital" means

Not every dollar a REIT distributes is "income" in the tax sense. When a distribution is classified as a return of capital, the IRS treats it as giving you back part of the money you originally invested, rather than as new earnings. That portion generally isn't taxed in the year you receive it, which is different from most other kinds of investment income, where tax is due in the year you're paid. See the glossary for a one-line definition.

Why REITs generate so much of it

Real estate accounting includes a large non-cash expense: depreciation. Tax rules let a property owner deduct a portion of a building's cost each year, even though no cash actually leaves the business to cover that deduction. A REIT can have healthy cash flow — the kind measured by metrics like FFO and AFFO — while reporting much lower taxable income once depreciation is subtracted. Because REITs typically distribute a high share of their cash flow rather than just their taxable income, the distribution can exceed taxable income, and the excess is classified as return of capital rather than a taxable dividend. This is a structural feature of how depreciation interacts with the distribution rules, not a sign that a REIT is struggling or paying out cash because it lacks better uses for it. It's also one reason a REIT's dividend can appear to exceed its reported accounting earnings per share without anything being amiss.

What it does to your cost basis

Return of capital isn't a free pass — it's a timing shift. Each return-of-capital payment reduces your cost basis in the shares by the same amount. Basis can't go below zero; once it hits zero, any further "return of capital" payments are instead taxed as a capital gain. This mechanism isn't unique to REITs, but it's especially common in the REIT sector because of how large a role depreciation plays in real estate accounting. As a simple illustration:

1. Buy shares with a $50 cost basis.
2. Receive $2 per share classified as return of capital.
3. Your adjusted cost basis becomes $48 per share.

Why it matters when you eventually sell

A lower cost basis means a larger taxable gain, or a smaller loss, whenever you sell the shares. In effect, return of capital defers tax rather than eliminating it — the bill often shows up later, at the capital gains rate, instead of now, at your ordinary rate. That can still be a reasonable outcome for a long-term holder, since capital gains rates are often lower than ordinary rates and the tax is postponed to a date of your choosing. But it isn't the same as tax-free income, and it means tracking your adjusted basis over time rather than just your original purchase price. Some income-focused investors specifically look for REITs with a meaningful return-of-capital component for this reason, though how much of any given REIT's distribution will be classified this way in a future year isn't something that can be predicted with precision in advance.

Where you'll see it

Brokers report return-of-capital amounts as "nondividend distributions" on Form 1099-DIV, separate from ordinary dividends and capital gain distributions. If you hold a REIT through a fund, the return-of-capital classification is calculated at the fund level first and then passed through to you, so your own basis tracking follows your fund shares, not the individual REITs the fund happens to hold. See Reading Your 1099-DIV for the full box-by-box breakdown, and How REIT Dividends Are Taxed for how this piece fits with the rest of a distribution.

A note on record-keeping

Because basis tracking spans years, and brokers don't always carry it forward perfectly across transfers between firms, it's worth keeping your own records of purchase prices and any return-of-capital adjustments, ideally updated each year as your 1099-DIV arrives. This is exactly the kind of detail where a tax professional or good tax software earns its keep — the rules are well established, but the bookkeeping adds up, especially if you've reinvested dividends over many years and bought shares at several different prices along the way.

See it in the data: Browse REIT profiles → Ex-dividend calendar →

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.