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REIT: Real Estate Investment Trust

by | May 3, 2024 | Income Tax | 0 comments

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Important Keyword: Income from Other Sources, Income Tax, REIT.

REIT: Real Estate Investment Trust

Real estate stands as a cornerstone of the Indian economy, playing a pivotal role in its rapid growth. However, investing in real estate often requires substantial capital and can pose challenges for small or retail investors. In this landscape, Real Estate Investment Trusts (REITs) emerge as a beacon of opportunity.

REITs serve as investment vehicles that allow individual investors to partake in real estate ventures without the burdens of direct property management or significant financial commitments. By pooling funds from multiple investors, REITs provide a pathway for retail investors to access income from real estate ventures and potentially benefit from the sector’s growth, all while mitigating the risks associated with individual property ownership.

What is a REIT?

Indeed, Real Estate Investment Trusts function as investment vehicles that mobilize funds from sponsors and investors, subsequently investing these funds into a diverse array of income-generating properties. These properties span across various sectors, encompassing office spaces, hospitals, shopping centers, hotels, warehouses, and more.

Real Estate Investment Trusts typically deploy these funds directly into real estate properties or through Special Purpose Vehicles (SPVs), effectively channeling investments into income-generating assets. The income generated by these properties can stem from rental income or interest earned from loans extended by the Real Estate Investment Trust.

In essence, the structure of Real Estate Investment Trusts mirrors that of mutual funds, which aggregate small investments from both individuals and institutions to invest in stocks. Unitholders of Real Estate Investment Trusts stand to benefit from dividends and interest distributions generated by the underlying real estate assets, providing a means for investors to access real estate income streams without the need for direct property ownership.

Types of REIT

REITs come in various forms, each catering to different investment preferences and risk profiles:
  1. Equity Real Estate Investment Trusts: These are the most common type of Real Estate Investment Trusts and are publicly traded on stock exchanges. Equity Real Estate Investment Trusts primarily own and manage income-producing commercial properties. Their main source of income stems from rental payments made by tenants occupying these properties.
  2. Mortgage Real Estate Investment Trusts (REITs): Unlike equity Real Estate Investment Trusts, mortgage Real Estate Investment Trusts are more involved in providing financing for real estate transactions. They extend loans and mortgages to property owners and invest in mortgage-backed securities. Their primary sources of income include interest earned from these loans and investments.
  3. Hybrid Real Estate Investment Trusts: As the name suggests, hybrid REITs offer a blend of both equity and mortgage REITs. Investors can diversify their portfolios by investing in a mix of rental income from properties and interest income from mortgage investments.
  4. Public Non-Listed Real Estate Investment Trusts (PNLRs): PNLRs are registered with regulatory bodies like the SEBI but are not publicly traded on stock exchanges. While they offer less liquidity compared to publicly traded REITs, they tend to be more stable as they are not subject to market fluctuations.
  5. Private Real Estate Investment Trusts: Private Real Estate Investment Trusts are exempt from SEC registration and their shares are not listed on national stock exchanges. These REITs operate as private placements, catering to a select group of investors. They offer opportunities for direct real estate investment without the regulatory requirements of publicly traded REITs.

Compliances

In order to qualify as per SEBI guidelines 2019, REITs must adhere to the following compliances:
  1. Asset Base Requirement: The Real Estate Investment Trust must have an asset base of at least 500 Crores to be eligible for registration and operation.
  2. Special Purpose Vehicle (SPV) Criteria: Any assets held by the Real Estate Investment Trust through a Special Purpose Vehicle (SPV) must meet specific requirements. The Real Estate Investment Trust should hold controlling interest in the SPV, and at least 50% of the total nominal value of equity in that SPV should be owned by the Real Estate Investment Trust.
  3. Distribution Requirement: Real Estate Investment Trusts are required to distribute a minimum of 90% of their net distributable cash flow to unitholders in the form of interest or dividends. This ensures that investors receive a significant portion of the income generated by the Real Estate Investment Trust.
  4. Investment Composition: At least 80% of the Real Estate Investment Trusts investments should be in income-generating assets such as rental properties, commercial real estate, or other revenue-generating properties. Additionally, only up to 20% of the total investment can be allocated to under-construction assets, equity shares, bonds, or other non-income generating assets. This requirement ensures that the majority of the REIT’s portfolio consists of income-generating assets, providing stability and income for investors.

Advantages of Investing in REIT

Investing in Real Estate Investment Trusts offers several benefits to investors:
  1. Diversification: Real Estate Investment Trusts provide investors with the opportunity to diversify their real estate holdings. Since Real Estate Investment Trusts typically own a portfolio of properties across different sectors such as office spaces, retail centers, and residential complexes, investors can spread their risk across various types of real estate assets.
  2. Dividend Income and Capital Appreciation: Investors in Real Estate Investment Trusts can earn regular dividend income from the rental income generated by the properties held by the Real Estate Investment Trust. Additionally, over the long term, investors may also benefit from capital appreciation as the value of the underlying properties increases.
  3. Liquidity: Real Estate Investment Trusts are often traded on stock exchanges, providing investors with liquidity. This means that investors can easily buy and sell Real Estate Investment Trust units on the open market, allowing for flexibility in managing their investment portfolio.
  4. Risk-Adjusted Returns: Real Estate Investment Trusts offer investors the potential for attractive risk-adjusted returns. By investing in a diversified portfolio of income-generating properties, investors can benefit from a steady stream of income while potentially mitigating some of the risks associated with individual property ownership. Additionally, during periods of high inflation, Real Estate Investment Trust investments may provide investors with a hedge against inflation by offering a stable source of income.

How to Invest in REIT?

Investors can purchase shares in a REIT through various avenues:
  1. Direct Investment: Investors can directly purchase shares of a specific Real Estate Investment Trust through stock exchanges, similar to investing in individual stocks.
  2. Mutual Funds: Those seeking a diversified portfolio can invest in Real Estate Investment Trusts through mutual funds. Mutual funds pool funds from multiple investors and invest in a variety of Real Estate Investment Trusts, providing investors with exposure to a broader range of real estate assets.
  3. Exchange-Traded Funds (ETFs): Investors looking for indirect ownership of properties and the benefits of diversification can opt for REITs through ETFs. ETFs trade on stock exchanges and represent a basket of Real Estate Investment Trust securities, offering investors exposure to a diversified portfolio of real estate assets.

Taxability of REITs:

  • Pass-through Status: Real Estate Investment Trusts have a pass-through status under Section 10(23FC) of the Income Tax Act. This means that the income earned by the Real Estate Investment Trust, such as interest and dividend income from Special Purpose Vehicles (SPVs), is distributed to unitholders and taxed in their hands, making it exempt for the REIT itself.
  • Exempt Income: Income earned by a business trust from renting or leasing real estate assets directly owned by the trust is exempt under Section 10(23FCA).
  • Taxation of Business Trust: The total income of a business trust includes various components such as interest and dividend income from SPVs, rental income, investment income, and capital gains. All income apart from capital gains is taxable at the Maximum Marginal Rate.

Taxation in the Hands of Unitholders:

  • Treatment of Income: Income distributed by the business trust to its unitholders is treated in the same proportion as it is receivable by the trust.
  • Taxable Dividend Income: Dividend income from Real Estate Investment Trusts is taxable in the hands of unitholders, especially when the SPV opts to pay taxes at a concessional rate of 22% under Section 115BAA.
  • Treatment of Repayment: Repayment of principal to unitholders is considered capital receipts and is deducted from the cost of acquisition when calculating capital gains on the sale of units.
  • Capital Gains Tax: Transfer of units by unitholders is subject to capital gains tax. Short-term capital gains are taxed at 15%, while long-term capital gains exceeding INR 1 lakh are taxed at 10%.

Read More: Income Tax on Interest Income

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Official Income Tax Return filing website: https://incometaxindia.gov.in/

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