A real estate investment trust and an infrastructure investment trust hand the holder a single cash distribution that is legally several different kinds of income, each taxed differently. The skill is reading the composition, because the total tells you very little.
Worked example: a $2,080 REIT distribution
Take 800 shares of a synthetic American trust bought at $42.50, a $34,000 position, receiving $2.60 a share in a year, or $2,080. The trust's own tax reporting splits that payment four ways: $1.72 of ordinary dividends, $0.18 of qualified dividends, $0.55 of return of capital and $0.15 of capital gain distribution.
Tax the four slices at a 24% ordinary rate and a 15% long-term rate, allowing the deduction available on qualified trust dividends [verify: the deduction for qualified business income as it applies to REIT dividends, IRC section 199A, irs.gov. This provision has a legislated life and its availability is not permanent]. The ordinary slice of $1,376 becomes $1,100.80 of taxable income and $264.19 of tax; the qualified slice is $21.60; the capital gain distribution is $18.00; the return of capital is nil. Total current tax is $303.79, an effective rate of 14.61% on the distribution. Treat the whole $2,080 as ordinary income, which is the naive default, and you would compute $499.20. The decomposition is worth $195.41 in a single year on a single holding.
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What happens to the return of capital?
Then do the part almost everybody skips. The return of capital was not tax-free. It was tax-deferred, and it changed the rate. The $440 reduces basis from $34,000 to $33,560, or $41.95 a share. Sell later at $46.20 and the gain is $3,400 rather than the $2,960 it would have been, so the tax at sale is $66 higher. Had the same cash arrived as an ordinary trust dividend it would have carried the same 20% deduction the ordinary slice above carried, so the tax deferred is 24% of 80% of $440, which is $84.48. Set the $66 against it and the net benefit is $18.48. That's a real gain, from deferral plus the conversion of ordinary-rate income into long-term-rate gain, and it's 21.9% of what the naive "return of capital is not taxed" reading would suggest.
How are Indian REIT and InvIT distributions taxed?
The Indian analogue works the same way with different labels. A trust's distribution to a unitholder splits into interest, dividend and repayment of the unit's cost, and each is taxed under its own rule. The repayment component doesn't escape tax. It reduces the cost of acquisition of the unit [verify: the taxation of business trust distributions in the income-tax statute as amended, incometaxindia.gov.in]. The trust publishes the split. Read it, apply three rates, and never take the yield at face value.