Many busy investors lose out on profitable investment opportunities because they don’t have a trusted advisor to help them navigate their taxation and financial plan. Is that you? Don’t let the absence of a professional advisor keep you from earning more by investing in REITs.
What are REITs?
A real estate investment trust (REIT) is a particular type of business that can invest in real estate, such as shopping centres, office buildings, hotels, and apartments.
REITs listed on an exchange like the NYSE or Nasdaq must pay out at least 90 percent of their taxable income as dividends to shareholders. The dividends that REITs pay can be a great source of income for investors.
How Do REITs Work?
Unlike other companies that raise capital through debt or equity, REITs raise capital by issuing shares of stock to investors.
The money raised from these sales is used to purchase properties for rent or resale purposes — all under strict guidelines set by the IRS. REITs can be publicly traded on a stock exchange or privately held by a small group of investors.
Role of Accountants in REITs
Real estate investments involve many transactions, including acquisitions, sales, and leases. Accounting helps ensure that these transactions are correctly recorded and reported on financial statements so that investors can access complete information about their investments.
For example, accountants can help identify when an acquisition is more costly than expected or when a property needs repairs or renovations before being leased out.
Accounting also helps determine whether leasing rates should be increased to generate greater revenue from existing properties or whether new properties should be acquired instead.
Accountants help REITs with three critical tasks:
1. Financial Reporting and Analysis
REIT accounting procedures ensure the company can produce financial reports accurately representing its financial health. They also perform other tasks like auditing and tax preparation.
2. Tax Planning and Compliance
Real estate investment trust accounting helps clients avoid being subject to extra taxes by setting up retirement plans or offering them tax breaks through depreciation deductions.
3. Compliance Management
Accountants help clients comply with accounting regulations for REITs set by federal agencies like the IRS or SEC and state-level agencies like California’s Department of Business Oversight (DBO).
Financial Reporting Requirements and Accounting Regulations for REITs
REITs must file with the SEC and make their annual reports available to investors.
In addition, they must comply with the same Generally Accepted Accounting Principles (GAAP) that apply to all other companies that trade on U.S. stock exchanges.
Compliance with GAAP is required for income tax purposes and reporting taxable income using an acceptable method under the Internal Revenue Code (IRC).
The IRC generally requires that taxable income be calculated according to accrual accounting principles. Financial statements are prepared using estimates of future events and transactions rather than actual amounts earned or incurred during a period.
REITs must report their financial results annually through financial statements prepared according to GAAP. These statements include:
Balance sheet
Cash flow statements
Income statement
Tax Considerations for REITs
One of the most significant benefits of owning REITs is that they are generally exempted from paying federal income tax. However, they must pay taxes on dividends they distribute to their shareholders.
These dividends are taxed as ordinary income at the investor’s marginal rate, which may be lower than the rate they would have paid if they had received them directly from the REIT.
The main issue for REIT investors is distinguishing between taxable REIT distributions and tax-free REIT dividends. REIT accounting software helps investors examine the difference between these two types of distributions while eliminating the need to keep track of numerous tax rules and regulations.
For example, investors do not have to worry about counting the distribution as ordinary or capital gains income. Instead, they can rely on their accountants to handle these details.
You can also see how much money each property contributes to your total income from all sources of income, including interest from savings accounts or CDs and dividends from stocks.
Best Practices for Accounting in REITs
Real estate fund accounting is a complex process and must be done correctly to ensure compliance with all applicable regulations. Here are some best practices:
Understand the taxonomy of REITs
Review the financial statements
Review the operating agreement
Document your findings
Keep track of all assets on a consolidated basis
Use the suitable accounting method – equity or cost
Common Challenges in REIT Accounting
Here are some common challenges in REIT accounting and how to address them:
1. The Complexity of Accounting for Real Estate Assets
Real estate assets are unlike other assets you purchase from retailers or manufacturers. The value of real estate assets fluctuates due to location, demand for space, market conditions, etc. Therefore, their valuation may frequently change over time.
2. Accounting for Financing Costs
Financing costs include interest on loans taken out by your company or any related parties to purchase real estate assets or fund operational expenses.
These costs must be accounted for using proper GAAP rules and regulations while disclosing them in the notes section of your financial statements so investors can understand how these costs affect your net income statement and cash flow statement.
3. Reliance on Debt Financing to Fund Acquisitions
This increases their leverage and puts pressure on cash flow.
As such, an accountant needs to understand how this affects balance sheets and income statements over time — mainly when calculating debt-to-equity ratios or determining EBITDA (earnings before interest, taxes, depreciation, and amortization).
Wrapping Up
Accountants play an integral role in monitoring and protecting the investments of REIT investors. Given the importance of their contributions, real estate investors should ensure their accountant is knowledgeable about the industry and its nuances.
In turn, advisors in the commercial real estate industry should leverage technology to facilitate communication between accountants and clients as needed to ensure that more detailed risk, legal, financial reporting, compliance, and regulatory requirements can be effectively addressed.
About Us
OHI is a sixteen-year-old real estate services company working with 100+ commercial and residential real estate developers, funds and property management companies across USA. Our deep expertise in real estate accounting, financial analysis, lease administration and asset management has helped clients cut associated costs by 40-50%. We currently provide these services to a portfolio of 150,000 units across clients.
OHI provides REIT accounting and related services through our team of experienced real estate portfolio accountants. OHI team members are well versed with US GAAP norms including real estate accounting rules including Real Estate Information Standards (REIS) as per NCREIF. OHI has experience with real estate companies that own and manage office, multifamily, retail, industrial and other real estate investments, including proficiency in both traditional and mortgage REITs. – VIEW MORE
