How to Start a REIT: Steps and Requirements

A real estate investment trust (REIT) lets investors own income-producing real estate through shares. REITs get special tax treatment. However, to form a real estate investment trust, a company must meet strict organizational, operational, distribution and compliance rules. Here is how to start a REIT, and the rules it must follow.

How to start a REIT: step by step

Here is how a REIT usually comes together, from the first plan to the first tax return. Each step is explained in more detail below.

Set the strategy. Decide what real estate the REIT will own (for example apartments, offices or mortgages) and whether it will be private, public non-traded or publicly traded.
Form the entity. Create a corporation, trust or association that is taxable as a domestic corporation. Many sponsors work with a securities attorney on the state of formation and offering documents.
Set up governance. A board of directors or trustees must manage the REIT, and shares must be transferable. The charter usually limits how much stock one person can own, to protect the ownership tests.
Plan the ownership. From the second tax year, the REIT needs at least 100 shareholders and must not be “closely held” (five or fewer individuals owning more than 50%).
Structure assets and income. Hold mostly real estate assets and earn mostly rents, mortgage interest and similar income, so the REIT passes the income and asset tests. Services that don’t qualify often go into a taxable REIT subsidiary.
Elect REIT status. File Form 1120-REIT for the first tax year you want REIT treatment. REITs use a calendar tax year.
Stay compliant every year. Distribute at least 90% of REIT taxable income, test assets every quarter and send yearly shareholder demand letters.

How a real estate investment trust must be organized

A U.S. REIT must be formed in one of the 50 states or the District of Columbia. In addition, it must be an entity taxed as a corporation for federal purposes. Directors or trustees must manage it, and its shares must be transferable.

Starting with its second tax year, a REIT must also pass two ownership tests:

100-shareholder test. The REIT must have at least 100 shareholders.
5/50 test. Five or fewer individuals can’t own more than 50% of the REIT’s stock value during the last half of the year.

To stay within these tests, most REITs limit how much stock any one person can own. Because the tests are complex, talk with tax and securities advisors before you form a REIT.

How a REIT operates: income and asset tests

Each year, a REIT must pass two income tests. Also, it must pass several asset tests every quarter. Together, these tests make sure most of its income and assets come from real estate.

Income tests

At least 75% of gross income must come from real estate sources. For example, these include rents from real property and interest on mortgage loans.
At least 95% must come from those sources plus other passive income, such as dividends and interest.
So no more than 5% can come from other sources, such as service fees or a non-real estate business.

Asset tests

At least 75% of the REIT’s assets must be real estate assets, cash or government securities.
A REIT generally can’t own more than 10% of the voting securities or value of another company. However, this limit doesn’t apply to other REITs, taxable REIT subsidiaries (TRSs) or qualified REIT subsidiaries.
Similarly, stock in any one such company can’t exceed 5% of the REIT’s assets.
Finally, TRS securities can’t exceed a set share of total assets. The 2025 tax law raised this limit from 20% to 25% for tax years beginning after 2025.

REIT dividend distribution rules

A REIT must distribute at least 90% of its taxable income to shareholders each year. If it keeps any income, it pays corporate tax on that amount, like any other corporation.

Compliance rules for a real estate investment trust

A company elects REIT status by filing its income tax return on Form 1120-REIT. Because the return is filed after year-end, the election also comes after the first year ends. Even so, the company must pass the REIT tests during that first year. The only exceptions are the 100-shareholder and 5/50 tests, which start in year two.

In addition, a REIT must send yearly letters to shareholders asking who owns its shares. Missing these letters can bring significant penalties.

REIT accounting and records

REIT accounting has to support these tests, not just the tax return. In practice, that means tracking income by type for the income tests, valuing assets each quarter for the asset tests, measuring taxable income so the company can meet the distribution requirement, and keeping the shareholder demand letters and responses on file.

Types of REITs

REITs are usually grouped by what they invest in and by how their shares are offered:

Equity REITs typically own and operate income-producing real estate. Most REITs are equity REITs.
Mortgage REITs provide financing to property owners and operators, either directly through mortgages and other real estate loans or by buying mortgage-backed securities. They tend to use more leverage than equity REITs.
Hybrid REITs combine both strategies.

By how shares are offered, publicly traded REITs file reports with the SEC and trade on national stock exchanges, non-traded REITs file reports with the SEC but don’t trade on an exchange, and private REITs are offered privately and are generally not registered with the SEC. The tax rules above apply to all of them. Source: SEC Investor Bulletin: Real Estate Investment Trusts.

REIT formation FAQs

How many shareholders does a REIT need?

At least 100, for at least 335 days of a 12-month tax year. This rule, like the 5/50 test, does not apply in the REIT’s first tax year.

Can I start a private REIT?

Yes. Private REITs are common, often owned by a fund or a small group of investors. They must still meet every REIT test, including the 100-shareholder rule from year two.

Can an LLC be a REIT?

An LLC can qualify if it elects to be taxed as a corporation and meets the REIT rules, including management by directors or trustees and transferable ownership interests.

How much does it cost to start a REIT?

Costs depend on the size of the offering and the legal, accounting and compliance work involved. Private REITs usually cost far less to set up than public ones. We can give you a quote for the tax side once we understand your plans.

How is a REIT taxed?

A REIT can deduct the dividends it pays, so income distributed to shareholders is generally taxed once, at the shareholder level. Income it keeps is taxed at corporate rates.

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Get help forming a REIT

Forming a REIT takes careful tax planning, from the ownership tests to the first-year election. Our team can help you structure the entity and stay compliant. To discuss your plans, call us at (415) 842-2940, email support@flextcg.com or book a free 15-minute call.