Earning income without corporate taxes, reducing taxable income, and deferring taxes are just a few ways private mREITs can boost your after-tax returns.
The tax benefits of private mREITs
For income-focused investors, private mortgage real estate investment trusts (mREITs) offer more than just high-yield potential—they also provide significant tax advantages.
The unique tax structure of private mREITs allows them to bypass corporate taxation, pass through depreciation benefits, and offer other tax-efficient income strategies.
Understanding these tax benefits, investors can make more informed decisions that enhance portfolio performance and long-term wealth preservation.
Let’s look at the popular tax advantages of private mREITs, including how they avoid double taxation, leverage depreciation, and offer tax-deferred income.
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Avoidance of corporate income tax
One of the most significant tax advantages of private mREITs is their ability to bypass corporate-level taxation.
Traditional corporations face double taxation, paying taxes on earnings before distributing dividends. REITs, however, are structured to bypass this issue.
To retain REIT status, an entity must pass on most of its taxable income—at least nine-tenths—to its shareholders.
It is exempt from federal corporate income tax on distributed earnings by doing so. This allows private mREITs to pass through higher dividends directly to investors without the additional layer of corporate tax.
Benefits for those in higher tax brackets
This exemption can significantly enhance after-tax income for investors, especially those in high tax brackets, compared to traditional dividend-paying stocks, since it will reduce their overall tax burden and maximize their wealth accumulation.
Additionally, this tax structure makes private mREITs attractive for those looking to balance risk and return while minimizing tax liabilities.
Pass-through depreciation benefits
Private mREITs often operate as limited liability companies (LLCs) or partnerships, allowing them to pass depreciation benefits directly to investors.
Depreciation deductions reduce taxable income, lowering the tax liability for investors receiving distributions.
For example, if an investor receives $10 per share in distributions but depreciation expenses reduce the taxable portion to $7, taxes are only owed on the lower amount.
This benefit is particularly valuable for high-net-worth individuals seeking tax-efficient income strategies. It improves cash flow and enhances the appeal of private mREITs as a long-term investment vehicle.
Section 199A deduction under the TCJA (Tax Cuts and Jobs Act)
The TCJA of 2017 brought in the Section 199A deduction, offering a notable tax benefit for REIT investors.
This provision allows U.S. investors to deduct up to 20% of qualified REIT dividends, lowering their tax rate.
This deduction reduces the effective federal tax rate on REIT dividends for top-bracket taxpayers from 37% to 29.6%.
This feature makes REIT dividends more attractive than fully taxable bond interest or non-qualified dividends from traditional corporations.
The Section 199A deduction is set to end after 2025 unless Congress decides to extend it, making it an important factor in current investment planning.
Proactive tax planning is essential for investors looking to maximize this benefit before it potentially expires.
Return of capital (ROC) distributions
A portion of private mREIT distributions may be classified as a return of capital (ROC), offering valuable tax-deferral benefits.
Unlike ordinary dividends, ROC distributions are not taxed when received.
Instead, they reduce the investor’s cost basis in the investment, deferring taxes until the shares are sold.
At that point, any gain is taxed at more favorable long-term capital gains rates rather than as ordinary income.
ROC distributions efficiently minimize annual tax liability for investors focused on preserving capital while generating income.
This feature enhances the appeal of private mREITs for those looking to manage tax exposure strategically.
Tax shield for tax-exempt investors
Private mREITs can also serve as an effective tax shield for investors using tax-advantaged accounts, such as IRAs, pensions, and foundations.
Many alternative investments generate unrelated business taxable income (UBTI), which can create tax liabilities for tax-exempt entities.
Private mREITs act as blockers, preventing UBTI exposure—an attractive option for investors looking to generate tax-deferred income within IRAs or 401(k)s without additional tax complications.
Private mREITs offer a unique advantage for retirement-focused investors seeking growth and income by combining tax deferral and UBTI protection.
Capital gains tax benefits of private mREITs
Investors who retain private mREIT shares for more than a year may become eligible for long-term capital gains tax treatment, which often offers more favorable rates than ordinary income taxes.
Long-term capital gains are generally taxed between 0% and 20%, depending on income level, while regular income tax rates can be as high as 37%.
This advantageous tax treatment enhances the appeal of private mREITs for those focused on building wealth efficiently.
By holding private mREIT shares long-term, investors can reduce the tax impact on their gains, aiding in wealth preservation.
For those with a longer investment horizon, this tax benefit makes private mREITs a strategic addition to a diversified portfolio.
Estate planning benefits of private mREITs
Private mREITs also offer advantages for estate planning, mainly through the step-up in cost basis rule.
When investors die, their heirs receive private mREIT shares at the stepped-up market value, eliminating capital gains tax on prior appreciation.
This allows for a tax-efficient transfer of wealth to the next generation, making private mREITs a valuable tool for estate planning.
Incorporating private mREITs into an estate plan for high-net-worth individuals can help preserve wealth while minimizing tax liabilities for heirs.
This tax advantage enhances the role of private mREITs in legacy planning.
Challenges and considerations
Despite their tax advantages, private mREITs come with certain complexities:
- K-1 tax reporting: Unlike publicly traded REITs, which issue simple 1099-DIV forms, private mREIT investors often receive K-1 statements, complicating tax filing.
- Liquidity constraints: Private mREIT shares are not publicly traded, requiring longer investment commitments and potentially limiting exit options.
- Regulatory compliance: To maintain their REIT status, private mREITs must comply with strict asset and income distribution requirements, which can affect operational flexibility.
Private mortgage REIT tax advantages–Final thoughts
Private mortgage REITs offer significant tax advantages, making them an appealing option for income-seeking investors.
By avoiding corporate income tax, passing through depreciation benefits, and providing tax-efficient distributions, private mREITs can enhance after-tax returns while offering inflation-resistant income.
Discover how private mREITs can generate long-term income while boosting your after-tax returns with Marquee Capital Fund 1 today.
Enjoy all the tax benefits of private mREITs, with hands-off passive income, a team of experts curating the fund, and sound investments fueled by in-house expertise.
Contact Marquee Investment Group today and let us know your investment goals.