Chartered Financial Analyst Level 2
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40 Assuming similar expected return and risk, distributions from which of the following investments will attract the most favorable tax treatment for US investors?
Exam-Like
A
Equity REITs
B
Real estate operating companies
C
Direct commercial property investments
Explanation:
Tax Treatment Explanation
Equity REITs (Option A) provide the most favorable tax treatment for US investors because:
- Dividend Tax Benefits: REITs are required to distribute at least 90% of their taxable income to shareholders, and these distributions are often classified as return of capital or qualified dividends
- Tax-Deferred Growth: Return of capital distributions reduce the investor's cost basis rather than being immediately taxable
- Capital Gains Treatment: When shares are sold, the difference between sale price and adjusted cost basis is taxed at favorable long-term capital gains rates
Comparison with other options:
- Real estate operating companies (Option B): Distributions are typically taxed as ordinary dividends
- Direct commercial property investments (Option C): Income is taxed as ordinary income, and investors face depreciation recapture and other complex tax implications
Therefore, Equity REITs offer the most favorable tax treatment for US investors.
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