Is it Wrong to Invest in REITs in RRSPs?

Income investors should consider REITs such as Simon Property Group Inc. (NYSE:SPG) and Plaza Retail REIT (TSX:PLZ.UN) for their portfolios.

| More on:
building

Real estate investment trusts (REITs) are income trusts that allow you to easily invest in real estate for monthly rental income. Investors should distinguish equity REITs (or eREITs) from mortgage REITs (or mREITs). eREITs invest in real estate properties, while mREITs provide financing for real estate. So, generally speaking, eREITs are safer investments.

How are Canadian REIT distributions taxed?

Canadian REITs are great income investments. Investors can easily find REITs with safe yields of 6% or higher. However, notably, REITs pay out distributions, which are taxed differently from the eligible dividends that most investors are used to.

Eligible dividends are taxed at favourable rates in taxable, non-registered accounts. How are Canadian REIT distributions taxed? Well, it depends. This is because REIT distributions can comprise of return on capital, capital gains, other income, and foreign non-business income.

In non-registered accounts, the return of capital portion is tax-deferred until unitholders sell or the adjusted cost basis of the REIT investment turns negative.

So, return of capital is essentially taxed like capital gains — at half your marginal tax rate. Then there’s other income and foreign non-business income, which are taxed at your marginal tax rate.

office building

Should you hold Canadian REITs in RRSPs?

Northview Apartment REIT (TSX:NVU.UN), H&R Real Estate Investment Trust (TSX:HR.UN), Plaza Retail REIT (TSX:PLZ.UN) offer safe yields of roughly 6.8%.

Because REITs don’t pay eligible dividends, they are more of a hassle for tax reporting in a non-registered account. That’s why some investors hold them in RRSPs or TFSAs.

However, for REITs with high portions of return of capital (which are tax-deferred), it’s really defeating the purpose to hold them in RRSPs, seeing as most returns from REITs will most likely come from their cash distributions.

On the contrary, if you find high-growth REITs or undervalued REITs that you believe will revert to the mean and appreciate big time at one point, it might make sense to invest in them in TFSAs or non-registered accounts.

What about U.S. REITs?

There’s a 15% withholding tax from dividends paid out from U.S. REITs held in non-registered accounts. So, ultimately, these foreign dividends will be taxed at the marginal income tax rate.

In RRSPs, there’s no withholding tax on the foreign dividends. So, investors can get the full dividend from U.S. REITs. You won’t get taxed until you withdraw from your retirement account, and the amount will be counted as taxable income.

Simon Property Group Inc. (NYSE:SPG) is a leading U.S. retail REIT that’s out of favour right now and offers a safe 5% yield. Other than focusing on the top-tier markets in the U.S., it also has iconic properties in other parts of the world, including in Japan, Canada, Korea, Austria, Germany, Malaysia, Mexico, the Netherlands, and the United Kingdom.

Investor takeaway

Investors should invest in Canadian REITs with distributions having high portions of return of capital outside of RRSPs. The tricky part is that the percentages of the constituents in REIT distributions can differ every year.

Investors should hold U.S. REITs with high yields, such as Simon Property, in RRSPs. However, investors might find it’s more tax-efficient to hold REITs with high growth and small yields in taxable non-registered accounts because most of the returns will come from capital appreciation, which is tax-deferred until you sell.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Kay Ng owns shares of Simon Property Group and Plaza Retail.

More on Dividend Stocks

TFSA (Tax-Free Savings Account) on wooden blocks and Canadian one hundred dollar bills.
Dividend Stocks

Where to Invest Your $7,000 TFSA Contribution

The TFSA is attractive for investors who want to generate tax-free passive income.

Read more »

The TFSA is a powerful savings vehicle for Canadians who are saving for retirement.
Dividend Stocks

TFSA Investors: 3 Dividend Stocks Worth Holding Forever

These TSX stocks have the potential to grow their dividends over the next decade, making them top investments for TFSA…

Read more »

Tractor spraying a field of wheat
Dividend Stocks

Is Nutrien Stock a Buy for its Dividend Yield?

Nutrien is down more than 50% form the 2022 highs. Is NTR stock now oversold?

Read more »

golden sunset in crude oil refinery with pipeline system
Dividend Stocks

Best Stock to Buy Right Now: Enbridge vs TC Energy?

Enbridge and TC Energy rebounded nicely over the past year. Are more gains on the way?

Read more »

Electricity transmission towers with orange glowing wires against night sky
Dividend Stocks

2 Utility Stocks That Are Smart Buys for Canadians in November

Are you looking for some of the smart buys to consider in November? These utility stocks offer growth and a…

Read more »

View of high rise corporate buildings in the financial district of Toronto, Canada
Dividend Stocks

Is Power Corporation of Canada Stock a Buy for its 5% Dividend Yield?

Is Power Corporation of Canada (TSX:POW) stock's 5% dividend yield worth it? Discover why this resilient stock could be a…

Read more »

hand stacks coins
Dividend Stocks

Here Are My Top 3 Dividend Stocks to Buy Now

These three dividend stocks are ideal for strengthening your portfolio and earning a stable passive income.

Read more »

man touches brain to show a good idea
Dividend Stocks

3 No-Brainer REIT Stocks to Buy Right Now for Less Than $200

REITs have long been touted as some of the best dividend stocks out there if you want recurring, strong income.…

Read more »