Understanding How Canadian REITs Are Taxed

Canadian real estate investment trusts (REITs) offer investors an efficient way to own diversified real estate assets while benefiting from preferential tax treatment. Under Canadian tax law, REITs themselves generally pay little to no tax at the trust level, provided they distribute at least 90% of their taxable income to unitholders. Instead, tax obligations flow through to investors, who must report various types of distributions, including return of capital, income, and capital gains, as necessary. 

Canadian investors can leverage tax deferral advantages through the return of capital that reduces adjusted cost base, while income and capital gains distributions are taxed at personal rates. 

Canadian REITs are structured under the Income Tax Act and must hold predominantly Canadian real property. They must also distribute most of their income annually. By distributing at least 90% of taxable income, REITs avoid paying corporate income tax at the trust level, allowing returns to investors without double taxation. These vehicles pool money from multiple investors to invest in income-producing properties like apartment buildings, office spaces, and other types of real estate, making it possible for individuals to access the real estate market without having to buy an entire property on their own. Shares (units) trade on public exchanges like stocks, offering liquidity and diversification.

Taxation Framework under the Income Tax Act

A REIT’s status as a real estate investment trust is defined in the Income Tax Act and requires adherence to asset and income tests, including limits on ownership concentration and qualifying property holdings. As trusts, REITs file T3 Trust Income Returns annually, issuing T3 Slips to unitholders. Unitholders do not pay tax at the REIT level; instead, they include distributions in their own tax returns.

Classification of Distributions

REIT distributions have three tax categories, each treated differently.

Return of Capital

Return of capital (ROC) distributions are not taxable in the year received but reduce an investor’s adjusted cost base. This deferral advantage can lower current tax liability, although later disposition of units may trigger a higher capital gain when the reduced ACB is recovered.

Income Distributions

Income distributions represent the REIT’s net rental and other ordinary income after expenses and are fully taxable as ordinary income to Canadian residents at their marginal rates. There is no preferential dividend tax credit for these amounts, meaning they bear tax at the same rate as employment income or interest.

Capital Gains Distributions

Capital gains distributions arise when a REIT sells property, and a portion of the gain is allocated to unitholders. Canadian residents include 50% of capital gains in taxable income (the inclusion rate), according to the general capital gains rules under the Act. Capital gains distributions are reported separately on T3 Slips and may be eligible for preferential treatment depending on circumstances.

Tax Implications

Canadian residents who own REIT units must report the income they receive from those investments on their personal tax returns. Each year, they receive a T3 Slip that breaks down how much of their distributions fall into the three different tax categories.

If you hold REITs in a registered account, such as an RRSP or TFSA, you can defer or even avoid paying taxes on the distributions. In an RRSP, taxes are deferred until you withdraw the funds, while TFSA accounts allow the investments to grow and be withdrawn tax-free.

Practical Considerations and Planning

Effective REIT tax planning involves:

• Maintaining accurate ACB records to track ROC adjustments and avoid unexpected capital gains.
• Using registered accounts to defer or eliminate tax on distributions.
• Reviewing a REIT’s financial statements and distribution breakdowns, which are often detailed in investor presentations and trust tax information, to make informed decisions.

Investors should maintain detailed records of cost base adjustments, understand T3 Slip reporting requirements, and consult professional advisors to optimize tax outcomes.

At SafeBridge, we bring over 20 years of experience helping investors navigate the financial and tax considerations of building real estate portfolios, including through REITs. Our team takes the time to understand your broader financial objectives and provides tailored guidance, whether you’re evaluating investment structures, planning for tax efficiency, or managing risk.