Are REIT dividends qualified dividends?

Mostly no. REIT distributions are generally taxed as ordinary income, because the trust passes its income through to shareholders without paying corporate tax on it first. Part of a distribution can be classed as a capital gain or a return of capital, and the Form 1099-DIV the payer sends shows the split.

Should I hold dividend stocks in a Roth IRA?

A Roth suits high-yield payers whose dividends would otherwise be taxed as ordinary income, since the income compounds with no yearly tax and qualified withdrawals come out tax free. Roth space is limited each year, so spend it on the holdings that would cost the most tax anywhere else.

Do I pay tax on reinvested dividends in a taxable account?

Yes. A reinvested dividend is taxed in the year it is paid, exactly as if you had taken the cash, and it adds to your cost basis in the new shares. Keep the reinvestment records so that basis is counted when you sell, or you can end up paying tax twice on the same money.

Dividend Stocks in a Taxable Account or an IRA: Where Each Belongs

Where a dividend stock sits decides how much of its income you keep. Portfolios can hold the same shares and collect the same payments and still end the year with different amounts after tax, because the tax code sorts dividends into qualified and nonqualified, sorts accounts into taxed and sheltered, and the combinations do not cost the same.

Qualified and nonqualified dividends

Qualified dividends are taxed at the long-term capital gains rates. Nonqualified dividends are taxed as ordinary income. That means your regular bracket.

A dividend only counts as qualified if you pass an IRS holding test.

Most REIT dividends land on the ordinary side whatever your holding period. So do some others. Business development companies and certain foreign companies are the usual examples. Their yields tend to run high.

The holding test mostly catches short trades. Buy a few days before the ex-date, sell soon after, and in a taxable account the payment is taxed as ordinary income whatever the company. Inside an IRA the test has no effect. Nothing is taxed that year either way.

That is where placement starts to pay.

The same $600 in each account

Take a hypothetical $10,000 REIT position yielding 6%. Set it beside the same $600 of income paid as qualified dividends. The tax rates are assumptions for the sum.

Inside a traditional or Roth IRA, neither payment is taxed in the year it arrives. The REIT saves $144. The qualified payer saves $90.

So the shelter is worth more to the REIT. Each year the $144 stays in the account it compounds along with everything else, and over a long holding period the gap between the placements widens year after year, which is why the highest-yielding ordinary-income payers are the first to claim IRA space when there is not enough room for everything.

Room is usually the constraint. Say you have space for one $10,000 position in the IRA, and both the REIT and the qualified payer want it. The REIT spares you $144 of yearly tax by moving in. The qualified payer spares you $90. The REIT gets the space. If the other candidate were a foreign payer with heavy withholding, the sum would change again, because that stock would lose its foreign tax credit inside the IRA, and the saving from moving it in would shrink by whatever was withheld abroad.

The dividend yield calculator gives the yearly income on your own position. Run the same comparison with it.

Why qualified payers sit well in a taxable account

A qualified dividend already gets the lower rate. In a taxable account it keeps other advantages as well.

Losses can be harvested. If the stock falls, you can sell it, take the loss and use it against gains elsewhere, within the IRS wash sale rule.
Foreign tax credits survive. Tax withheld abroad on a foreign company’s dividend can generally be claimed as a credit or a deduction on your US return.
Nothing is added on the way out. Selling shares from a taxable account is a capital gains event, taxed at the lower rates if held long enough.

The traditional IRA has the opposite problem at withdrawal. Money taken out of one is taxed as ordinary income. A qualified dividend earned inside a traditional IRA therefore ends up taxed at ordinary rates when you finally spend it, having given up its lower rate for the years of deferral.

A Roth avoids that. Qualified Roth withdrawals are tax free, so a qualified payer inside a Roth loses nothing at withdrawal. The Roth or traditional IRA guide covers which account suits which saver.

What the IRA takes away

The shelter has a price. Foreign dividends lose the foreign tax credit inside an IRA, since the account pays no US tax for a credit to offset, and whatever was withheld abroad is simply gone.

Losses are stuck too. A stock that halves its dividend and its price inside a traditional IRA gives you no deduction at all. It just sits there.

Those costs push some payers back out. A foreign stock with heavy withholding can cost more inside the IRA than outside it, even though its dividend is ordinary income, because the tax taken abroad is lost for good in the IRA and can be credited back in a taxable account. A volatile high yielder you might sell at a loss is worth more where the loss can be used.

For whether to own individual payers or a fund at all, see dividend ETFs against dividend stocks. More on income portfolios is on the dividends desk.

The verdict: ordinary-income yield goes in the IRA first

Put REITs and other high-yield, nonqualified payers in an IRA. Traditional or Roth both work, because in either one the income escapes the yearly tax that would otherwise take a quarter or so of it at the assumed rate. Keep qualified payers in the taxable account, where they already get the lower rate and hold on to loss harvesting and the foreign tax credit, so a loss can still do some good when one of them goes wrong. Make exceptions for foreign payers with heavy withholding. Make them for anything you expect to sell at a loss.