Chartered Financial Analyst Level 2

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.