How to Start a REIT

Starting a REIT means building an eligible operating structure

REIT status is a federal tax classification with continuing conditions. It is not created merely by putting the word REIT in a company name, purchasing a rental property, or selling interests to investors. The organization must fit the statutory definition, make the required election, and satisfy the relevant ownership, income, asset, and distribution requirements. State-law formation and federal tax qualification are related parts of the project, but they are not the same filing.

The principal framework appears in 26 U.S.C. 856 and 26 U.S.C. 857. It applies across different ways of raising capital and trading shares. For an introduction to the businesses that use this structure, the overview of REITs explains how real estate ownership and financing fit within the broader REIT market. Formation is an organizational undertaking, distinct from purchasing shares in an existing REIT.

The entity must satisfy the legal and governance requirements

Section 856 describes an eligible corporation, trust, or association managed by trustees or directors. Its beneficial ownership must be represented by transferable shares or certificates of beneficial interest, and it would otherwise be taxable as a domestic corporation. The statute excludes specified financial institutions and insurance companies. These organizational conditions are part of qualification, alongside the financial tests discussed below.

The practical formation work therefore includes the governing documents, ownership rights, management arrangements, and tax classification of the entity. An existing real estate business converting to REIT treatment must also examine its history. The IRS Form 1120-REIT instructions address accumulated earnings and profits from non-REIT years and other conditions that can matter to a conversion. An entity's existing legal form does not by itself establish that every REIT condition is met.

At least 100 shareholders and the five-or-fewer ownership test

Under section 856(a)(5), beneficial ownership generally must be held by at least 100 persons. Section 856(b) requires this condition for at least 335 days of a full 12-month taxable year, or a proportionate part of a shorter year. Section 856(h)(2) provides a first-tax-year exception to the shareholder-count and closely-held conditions. The IRS qualification instructions explain that these ownership requirements begin in the second tax year.

The closely-held rule is commonly called the five-or-fewer test. Section 856(h) incorporates the ownership test in 26 U.S.C. 542(a)(2): more than 50% of the value of outstanding stock cannot be owned, directly or indirectly, by or for five or fewer individuals at any time during the last half of the taxable year, subject to the REIT-specific rules. Having 100 names on a shareholder list does not by itself satisfy this separate concentration requirement.

Attribution and beneficial ownership rules can make the analysis different from simply reading a stock ledger. The qualification process includes identifying who owns the interests and how indirect holdings are counted. The first-year exception supplies a timing rule, not a permanent exemption from diversified ownership. A founder can organize the business, but a plan that depends on indefinite sole ownership would not fit the general continuing ownership requirements.

The 75% and 95% gross income tests

Section 856(c)(3) generally requires at least 75% of gross income to come from specified real estate sources. These include qualifying rents from real property, interest on obligations secured by real property, and certain gains from real property. The statute also identifies other qualifying categories and exclusions. The test measures income under the tax rules, not the percentage of employees working in real estate or the share of assets described as property investments.

Section 856(c)(2) separately requires at least 95% of gross income to come from its broader list of qualifying sources, which includes dividends, interest, and qualifying real estate income. Both tests must be considered. An amount can qualify for the broader test without qualifying for the narrower real estate test. The statutory income categories contain detailed definitions, including special treatment of certain transactions, rather than a blanket rule that every payment received by a property company qualifies.

Lease terms, services to tenants, and related-party arrangements can change the classification of receipts. Section 856(d), for example, defines qualifying rents and describes exclusions. This is why an operating plan has to be examined before assuming its revenue will pass the tests. Ongoing records must distinguish the relevant categories across the tax year; the business description used in an offering document does not replace those calculations.

The 75% asset test is measured at quarter end

Under section 856(c)(4), at least 75% of the value of a REIT's total assets generally must be represented by real estate assets, cash and cash items, and government securities at the close of each quarter. This is a balance-sheet test, separate from the annual gross income tests. It requires attention to the statutory meaning of an asset category and the applicable valuation rules, not just the accounting label assigned to an investment.

The same provision imposes additional limits on other securities and particular holdings. Satisfying the headline 75% test does not remove those conditions. Acquisitions, dispositions, financing transactions, and subsidiary arrangements therefore have to be considered within the full section 856 asset framework. The statute includes relief provisions for some failures, but they have conditions and cannot be treated as an automatic cure or a substitute for monitoring.

The 90% distribution requirement uses taxable income

The distribution requirement is set out in 26 U.S.C. 857(a). In general, the dividends paid deduction, excluding capital gain dividends, must equal or exceed 90% of REIT taxable income computed before that deduction and excluding net capital gain. The formula also includes adjustments for net income from foreclosure property and excess noncash income. It is not a requirement to pay out 90% of rent collected, property value, or accounting revenue.

Taxable income and available cash are different measures. The business's distribution planning must account for the tax calculation as well as its financing and operating obligations. Meeting the distribution threshold does not guarantee that no tax remains at the entity level: retained taxable income and other specified items can be taxable. The dividends paid deduction explains the structure's tax treatment without promising a particular dividend yield or an investor return.

Private, public non-traded, and listed REIT structures

The tax election does not dictate whether shares trade on a stock exchange. Investor.gov's bulletin on non-traded REITs distinguishes publicly traded REITs, public non-traded REITs, and private REITs. All three descriptions concern access to capital and the market for shares; none removes the need to satisfy applicable REIT tax requirements.

• Private REITs do not list their shares on an exchange. Their offerings rely on an exemption from securities registration, and investor eligibility and offering conditions depend on that exemption. They do not provide the same regular public reporting as SEC-registered REITs.
• Public non-traded REITs are registered with the SEC and file reports, but their shares are not listed on an exchange. Any redemption program has its own terms and limits. Registration does not create a continuously available trading market.
• Listed REITs have exchange-traded shares and public reporting obligations. Their market price can change as investors trade. An exchange listing is a separate step from forming the entity or making the federal tax election.

The capital-raising documents describe the structure's risks, governance, fees, and liquidity arrangements. A private offering is not outside securities law merely because it is exempt from registration. The SEC's exempt-offering questions and answers explain that each exemption has its own conditions and that state securities laws can also apply. This guide does not select an offering exemption for a particular sponsor.

Form 1120-REIT and SEC registration serve different purposes

According to the IRS Form 1120-REIT instructions, an eligible organization makes the REIT election by computing its taxable income as a REIT on Form 1120-REIT. The return reports income, gains, losses, deductions, credits, and the entity's tax liability. Filing the form is part of the election process; it does not waive the underlying qualification tests or authorize the sale of securities.

The SEC's Form S-11 is used to register securities issued by REITs and certain other real estate issuers under the Securities Act of 1933, subject to the form's eligibility rules. The form is not an IRS REIT election. Whether a registered offering, an available exemption, or another permitted filing route applies is a separate securities-law analysis.

The SEC overview of registered offerings describes the registration process and its place in raising public capital. Public reporting and any exchange requirements continue after an offering. As a result, completing formation documents is only one milestone. The tax calendar, disclosure responsibilities, and investor communications must also be supported by the organization that will operate the REIT.

Typical workstreams in forming a REIT

The sequence below summarizes the work implied by the tax requirements and offering disclosures described above. It is a general planning framework rather than a legal filing checklist. Some tasks run together, and an existing company conversion can involve different transactions from a newly organized property owner. The relevant documents and professional reviews depend on the actual assets, investors, and intended offering.

• Define the proposed business and assets. Identify the property or mortgage activities, expected receipts, financing, and any services or subsidiaries that affect the income and asset tests.
• Design the entity and governance. Establish the appropriate legal documents, directors or trustees, transferable ownership interests, and records needed to identify beneficial owners.
• Evaluate the capital-raising structure. Determine which securities registration requirements or exemptions apply and prepare the corresponding investor disclosures and subscription or offering documents.
• Coordinate transactions and qualification. Review acquisitions, ownership concentration, asset values, taxable income, and distribution arrangements against the applicable REIT tests.
• Complete the election and reporting work. Prepare Form 1120-REIT and relevant tax records, while maintaining any separate securities filings and investor reporting obligations.

Formation timelines and costs depend on the project

There is no single formation schedule that covers a private property company, a conversion, and a registered public offering. The stages depend on entity organization, asset due diligence, financing, investor subscriptions, financial reporting readiness, and any registration work. The recurring qualification calendar is more specific: annual income tests, quarter-end asset tests, ownership testing periods, distributions, and return preparation have to fit together.

Costs can include legal and tax work, accounting and financial statements, securities offering expenses, administration, and the actual acquisition and operation of real estate. Item 31 of SEC Form S-11 directs issuers to provide issuance and distribution expense information under Regulation S-K, while Investor.gov describes fees and conflicts associated with non-traded structures. Neither supplies a universal startup budget. A fee for establishing an entity is not the full cost of building and maintaining a compliant investment business.

One-time formation expenses also differ from recurring operating and reporting costs. The ongoing organization needs reliable ownership records, accounting, tax calculations, and communication with shareholders. The size and complexity of the property portfolio and the offering structure influence that work. This guide therefore presents cost categories and dependencies instead of inventing a minimum dollar amount or a promised launch date.

Maintaining REIT status after formation

The election remains relevant in later years, but qualification is not a one-time event. The IRS instructions explain that an election can terminate when the organization fails to qualify, subject to applicable statutory relief. Changes in ownership, operations, asset composition, or distribution decisions can therefore matter after the first return is filed. The existence of a previous REIT election is not evidence that every later transaction satisfies the rules.

The source materials below provide the governing definitions and public-agency explanations behind this introduction. Hoya Capital's Income Builder research provides context on the operating businesses and property sectors represented in the REIT market. Research about listed companies can help explain industry terminology, but it does not replace entity-specific legal and tax analysis for organizing a new REIT or converting an existing business.

Related Guides

• Overview of REITs: What REITs are, how they earn and distribute income, and the main REIT types.
• How to Invest in REITs: Account types, individual REITs versus funds, and the metrics investors review.
• How Are REITs Taxed?: How REIT dividends are reported and taxed, including inside IRAs.

Sources

• 26 U.S.C. 856: Definition and qualification of a REIT
• 26 U.S.C. 542: Incorporated stock ownership test
• 26 U.S.C. 857: REIT distributions and taxation
• IRS instructions for Form 1120-REIT
• SEC Form S-11: Registration of securities of certain real estate companies
• Investor.gov bulletin on non-traded and private REITs
• SEC frequently asked questions about exempt offerings
• SEC types of registered offerings

Frequently Asked Questions