Regarding your column about grocery-anchored real estate investment trusts, can you explain how their distributions are taxed?
I’m glad you called them distributions, and not dividends, because payouts from REITs are not the same as dividends from corporations. Canadian dividends generally qualify for the dividend tax credit, which can substantially reduce an investor’s tax burden. REIT distributions, on the other hand, typically consist of a mix of capital gains, return of capital and other income, each of which is subject to different tax treatment. Occasionally, REIT distributions also include a small amount of dividends or foreign income.
The exact tax breakdown varies from REIT to REIT and generally changes from year to year, which means the after-tax income of unitholders will also vary.
Here’s the good news: If you hold your REITs in a registered account, you don’t have to worry about any of this because the distributions are not taxable. However, if you hold your REITs in a nonregistered account, knowing the tax implications will help you determine how much of the distribution will stay in your pocket and how much will go to the government.
Fortunately, this information is relatively easy to find. Most REITs publish the annual tax characteristics of their distributions in the investor relations section of their website. The relevant dollar amounts are also included on the T3 Statement of Trust Income Allocations and Designations issued by your broker, although the amounts may be commingled with income from other securities.
Let’s look at Choice Properties REIT CHP-UN as an example. Choice is Canada’s largest REIT, with a portfolio that is heavily tilted toward grocery-anchored retail centres but also includes industrial, residential and mixed-use properties.
If you go to Choice’s website and click on “Investors” and then “Tax History,” you’ll find a tax summary for the REIT’s annual distributions going back 10 years.
In 2022, for example, Choice’s distribution of about 74 cents per unit consisted primarily of regular income (89.4 per cent), plus smaller amounts of capital gains (9.6 per cent) and return of capital (1 per cent). This tells you that the vast majority of Choice’s distribution in 2022 is taxable at the investor’s regular marginal rate.
Capital gains and return of capital are both taxed more favourably. Only half of capital gains are included in income for tax purposes. Return of capital isn’t taxed at all – at least not immediately. Rather, investors deduct return of capital from the adjusted cost base of their units, which will increase their capital gain, or decrease their capital loss, when they eventually sell the investment.
It’s not hard to find REITs with more favourable tax treatment than Choice. Distributions from Crombie REIT CRR-UN-T, for instance, were split fairly evenly between capital gains (48 per cent) and other income (52 per cent) in 2022. Canadian Apartment Properties REIT’s CAR-UN-T distributions were even more tax-friendly, with capital gains (about 68 per cent) accounting for more than twice the amount of other income (about 32 per cent), which is taxed at the investor’s marginal rate.
Where is the best place to hold REITs?
Generally, REITs such as Choice that pay a high proportion of regular taxable income are best suited for registered accounts to shield the distributions from tax. Because REITs that distribute relatively large amounts of capital gains and return of capital are taxed more favourably, they can be suitable for nonregistered accounts if you don’t have room in your registered retirement saving plan, tax-free savings account or other registered accounts.
I own Brookfield Infrastructure Partners LP BIP-UN-T and Brookfield Infrastructure Corp. BIPC-T in a registered account. If I wanted to switch my BIPC shares to my nonregistered account, can I do so without selling those shares first? In other words, can I simply arrange a transfer in-kind?
Yes, you can transfer shares without selling them first. You would need to contact your broker to arrange this. But be careful: If you are withdrawing shares from a registered retirement savings plan or registered retirement income fund, the market value of your BIPC shares will be fully taxable as income and, in the case of an RRSP, will also be subject to withholding tax (which is credited toward your final taxes owing when you file your return). Withholding tax does not apply to RRIF withdrawals as long as the amount is equal to or less than your required minimum RRIF withdrawal for the year.
If you are transferring your BIPC shares from a tax-free savings account to a nonregistered account, on the other hand, there are no tax consequences. What’s more, the market value of the BIPC shares at the time of the withdrawal can be added to your TFSA contribution room on Jan. 1 of the following year. With RRSPs, when you make a withdrawal you do not get the contribution room back. Keep that in mind as you decide what to do with your BIPC shares.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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John Heinzl