Dividends. A taxable event? Maybe. But I still love them.
If you have been paying attention to my “passive income” page, you might have noticed the Max Out of Pocket crew cleared $3,298 in dividends from my medical office building (MOB) REIT experiment in 2020. I sometimes refer to this as my ‘rental’ income. Not bad for a little side hobby.
But how much of that is taxable in 2020?
I initially spread the portfolio out over our taxable brokerage and tax-advantaged retirement accounts. This made things a little convoluted. But for tax purposes, in 2020, all that matters are the dividends that hit my taxable brokerage account.
My Uncle Sam did not tax the dividends in my tax-advantaged accounts in 2020. The ROTH IRA dividends will never be taxed, and the traditional IRA will get taxed like regular income at retirement age. For more on this see: Where do I Keep all of these Medical Office Buildings? I am in the process of simplifying things by closing the positions in my tax-advantaged account. These speculative investments don’t belong there. By the end of 2021, my entire REIT portfolio will be in my taxable brokerage account.
So out of the $3,298 in 2020 REIT dividends, only $1,539 was deposited into my taxable brokerage account. That comes in at just under 47% of the total.
But how much tax did we have to pay on that $1,539?
Taxable REIT Dividend Break Down
Coming in at $1,539, the dividend distributions in my taxable account are up a staggering 733% from 2019, when we had just $185. I suppose I have been putting a decent effort into building a taxable income stream from my MOB REIT portfolio.
We currently own three healthcare REITs in our taxable brokerage account. These REITs mostly give me exposure to the relatively stable medical office building space. Between the three REITs, this is how the dividends came in in 2020.
- Global Medical REIT = $637.20
- Physician Reality Trust = $624.14
- Welltower Inc = $276.94
$637.20 + $624.14 + $276.94 = $1,539.28
Here are all of the fourth-quarter dividends that hit my Fidelity account in late 2020.
I find non-dividend distributions interesting. The real estate investment trust is returning part of my original investment back to me. In other words, they don’t issue these payments from the corporation’s earnings or profits. These distributions reduce my cost basis in the REIT and the IRS won’t tax me until I sell the position.
Just over 39% of the $1,539 in REIT dividends I received in 2020 were considered non-dividend distributions. This total came in at $606. In other words, 39% of the cash flow generated from this investment will not be taxed in 2020.
When I do sell the position, we will pay the capital gain tax rate. But in the meantime, I can reinvest the cash. The $606 distribution represents about 52% of the dividends I received from GMRE and DOC. I did not receive any non-dividend distributions from Welltower in 2020.
Section 199A Dividends
If you recall from my 2019 experiment, a good chunk of this income is considered Section 199A Dividends. In our case, $824 of this income falls into this category. These dividends are treated very much like non-qualified dividends and are taxed like regular income from my W2 job. That said, they don’t get hit with FICA taxes like my regular income.
Here is the total:
Since Mrs. Max OOP is not working much these days, that keeps our income nice and low. So these dividends landed nicely square in the 22% tax bucket.
One thing that is nice about my Section 199A Dividends is they come with a special qualified business income deduction.
Qualified Business Income Deduction
Just like any other tax deduction, the qualified business income (QBI) deduction reduces our taxable income. The calculation on this is simple. We simply take my Section 199A Dividends and multiply them by 20%.
$824 X 20% = $165 QBI tax deduction
This deduction allows me to deduct $165 from our income and excludes that from taxes leaving $659 taxed at the 22% tax rate. That brings us closer to 17.5% tax rate on this portion of the dividend.
$659 X 22% = $145 Tax
Long Term Capital Gains
Last, we classify a portion of Welltower’s dividend distribution as a long-term capital gain. This total came in at $108.81, and it will be taxed at the long-term capital gain rate. In 2020 this was 15% for the Max Out of Pocket crew.
$108.81 X 15% = $16.32
Here is a summary of how our 2020 taxable REIT dividend income breaks down:
- Non-dividend distributions = $606 (taxed at 0% in 2020)
- Section 199A dividends = $824 (taxed at 22% after QBI deduction)
- Long term capital gains = $109 (taxed at 15%)
- Total = $1,539
The 2020 taxes on this income came in at $161, which equates to about 10.5%. Of course, we will need to plan for future capital gains taxes on those non-dividend distributions. I am okay with that, and I think there is some strategy there.
Cashflow-wise, that leaves us with $1,378. Again, not bad for a little side hobby.
It is amazing what you can do with your extra capital when you live a reasonable standard of living. After taxes, this $1,378 in income would cover about 3% of our 2020 annual spending, and this is just a small piece of our portfolio. Could I have made more money elsewhere? Of course. But I like boring.
I should also mention, this REIT income above was included in our total 2020 investment income summary from several weeks back.
I am sure some will wonder why I go through the effort of building this MOB portfolio. Why not invest it into the total stock market index like the rest of my portfolio? There are three answers:
The first and most important is education. I am trying to educate myself on how taxes and REIT dividends work. When I started this two years ago, I had no idea non-dividend distributions existed. I also did not know about the qualified business income deduction. Some of the tax advantages here have been a pleasant surprise.
Secondly, I consider this speculative investment that is a separate and distinct strategy from the total stock market index. I am not trying to beat the total stock market index with it, and I am just trying to build a dependable income stream that I understand and is diversified from the total stock market index that is currently sitting at an all-time high.
Finally, I just needed a another hobby.
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