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The following excerpt is taken from this very interesting piece on Real Estate Investment Trusts (REITs).
http://www.fool.com/Research/2001/foolsden010109.htm
My question, stated at the end of the quotation, is about REITs in a standard IRA.

Tax benefits
REITs are creatures of the tax code, which might explain why many individual investors have shied away from them. Yet, buying shares in a REIT is no different than buying shares of Intel.

REITs benefit from not paying corporate tax (most of the time) and pass this benefit on to their shareholders with healthy dividends. The dividend requirement has two major impacts: It limits the growth pace of REITs by reducing their re-investable capital, and it exposes individual investors to the unfamiliar practice of adjusting the cost basis of stock. "Ugh," I can hear you saying. "I don't want to have to keep records on the basis of my stock!" Don't worry, it's easy and definitely worth it.

It is not uncommon for REITs to pay out a dividend that exceeds their "taxable income." This results in a portion of the dividend being classified as a "return of capital" under the tax code. Last year, the return of capital portion was 18.5% on average. Rather than pay income tax on the entire cash dividend, you only pay tax on the ordinary income portion of the dividend and reduce the basis of your holdings by the return of capital amount. Sounds confusing, but it is simple to track and it usually results in paying a lower tax on dividends.

Here is an example: Johnny Investor owns 100 shares of Skyscraper, Inc. (Ticker: TALL) with a $25 per share basis for total holdings of $2,500. Skyscraper pays a $2.50 dividend per share annually, netting Johnny $250 in dividends by the end of the year. Johnny is in the 28% income tax bracket. Normally, Johnny would pay tax of $70 ($250 x 0.28) on his dividend income. But, before filing his taxes in April, Johnny checks the NAREIT website for 1099 information on Skyscraper's dividends. He notices that $0.50 of the $2.50 per share dividend is classified as a return of capital, therefore he only reports $200 of dividend income and subsequently reduces the basis of his Skyscraper shares to $2,450 ($2,500 less $50).

The immediate result is a lower tax. Johnny pays $56 ($200 x 0.28) in taxes rather than $70. But, the real tax savings are realized at the time of sale. When Johnny sells his shares, assuming he has held them for more than 12 months, the cost basis of his stock is lower, resulting in a higher capital gain and a higher capital gain tax. Why is a higher capital gain tax better, you ask? It has a maximum tax rate of 20%, much lower than the 28%, 31%, and 39.6% ordinary income tax rates that dividends are subject to. Effectively, Johnny has deferred taxes on cash received and lowered his tax rate.


My questions:
As described above, is it possible to benefit from 1) the ordinary tax reduction of a REIT and 2) the capital gains tax advantage of a REIT if the REIT is held in a standard IRA where no tax is paid anyway until a withdrawal is made? (I am assuming that the proceeds of the sale in scenario #2 remain inside the IRA – no withdrawal).

Is it possible to claim the benefits at the time withdrawals are made from the IRA? Or is it a better bet to simply invest in a REIT in a taxable account?

Perhaps I have missed something or perhaps I have invented a problem. I would appreciate the insight of a more experienced person in this matter.
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