REITs LTCG Rule Changes 2024: Investor Benefits Unveiled
The Union Budget 2024-25 has introduced a welcome changes to the long-term capital gains (LTCG) rules for Real Estate Investment Trusts (REITs). Previously, investors had to hold REIT units for 36 months to qualify for LTCG benefits. This holding period has now been reduced to 12 months. Now, it is align REITs with other listed equity shares. This change is likely to enhance liquidity, increase transaction volumes, and attract a broader investor base.The new LTCG rules for REITs are expected to make it a more appealing investment option. It is especially true for those seeking quicker returns (returns in short terms). People who invest in stocks for dividend income, for such investors REITs have now become at par with normal stocks.These adjustments are likely to drive significant growth in the commercial real estate market and provide substantial benefits to both short-term and long-term investors. The reduction in the holding period for LTCG from 36 months to 12 months for REITs increases liquidity and investor participation. It will lead to more frequent transactions and capital flow into REITs.Though share trading in secondary market cannot cause direct capital flow to REITs (as share transactions are between investors), but it will have an indirect benefit. However, the increased liquidity and attractiveness of REITs can lead to higher demand and a rise in REIT unit prices. This can encourage REITs to issue new units or raise additional capital through follow-on offerings (FPOs). This fund influx is then invested into the commercial real estate market. This way it can drive growth and development of the REITs.In this article, I will share my understanding on this recent changes in REITs LTCG rule. We’ll explore its potential advantages for investors.Topics:1. Recent Changes in LTCG Rules for REITsThe Union Budget 2024-25 has introduced a change in the LTCG rules for REITs. Previously, investors were required to hold REIT units for 36 months to qualify for LTCG benefits. This holding period has now been reduced to 12 months.This change brings REITs at par with listed equity shares. By aligning the holding period with that of equities, the government aims to enhance liquidity in the REIT market. This way the government wants to encourage more frequent trading. It is an indirect way to attract a broader investor base.I personally feel that, this increased liquidity can make REITs a more dynamic and appealing investment. This will surely drive up the potential demand and unit prices of REITs.1.1 Revised Tax RatesIn addition to the reduced holding period, the new LTCG rules introduce revised tax rates for REITs.LTCG on REITs, held for more than 12 months, will now be taxed at 12.5%. This is a favorable rate compared to other asset classes and is designed to encourage long-term investment in REITs.STCG, on the other hand, the tax implications remain less favorable. Gains from REITs held for less than 12 months will be taxed at the investor’s applicable income tax slab. Though, STCG tax rate can be significantly higher for high-income individuals, but at least it is at part with equity.1.2 Implications for InvestorsThese changes have several implications for investors:The reduced holding period lowers the barrier to achieving long-term capital gains status. This potentially makes REITs a more flexible and welcoming investment alternative.The favorable long-term tax rate of 12.5% provides an additional incentive for holding REITs for at least a year.Investors also need to be mindful of the higher tax rates on short-term gains, which could impact their overall returns if they decide to sell REIT units within a year.These adjustments aim to strike a balance between encouraging long-term investment in REITs. Increasing investment will provide enough liquidity to keep the market active and appealing to a broad range of investors.2. Impact on Investor ParticipationThe reduction in the holding period for LTCG on REITs from 36 months to 12 months is good for investors. This change means investors can now qualify for favorable LTCG tax treatment after just one year of holding REIT units. Favourable tax treatment gives more flexibility in the hands of the investors to take investment decisions.The recent reduction in the LTCG holding period results in enhanced liquidity. It allows the investors to achieve favorable tax treatment in a shorter time frame. For example, consider an investor who buys REIT units and plans to sell them after 14 months. Under the previous rules, they would have had to hold the units for an additional 22 months to benefit from the LTCG tax rate.For many investors, the 36 month rules could have been a potential limiting factor preventing them to invest in REITs. Now, with the holding period reduced to 12 months, the investor can sell earlier still enjoy the lower tax rate. This flexibility encourages more frequent buying and selling of REIT units, increasing market activity and liquidity.Experts believe that these changes will particularly appeal to retail investors. These category of investors were previously deterred by the long holding period. The shorter holding period, combined with the favorable tax rate of 12.5%, brings REITs at part with other equity instruments like mutual funds and stocks.By making REITs more accessible and attractive, the market is expected to see a significant uptick in retail participation. This influx of new investors can drive further growth and stability in the REIT sector.3. Investment in REITs over Direct Property Investment After July 2024The recent modifications to the LTCG rules for REITs came alongside changes to the LTCG rules for direct real estate investments. These simultaneous changes present a significant comparative advantage for REITs. How? Let’s know about it.We’ve already seen how the reduction of the holding period for LTCG from 36 months to 12 months for REITs has brought it at par with other pure-equity investments.There has been a simultaneous change in LTCG rules for direct real estate investments includes the removal of indexation benefits. Indexation allowed investors to adjust the purchase price of their property for inflation. This, thereby used to reduced their taxable gains. Without these benefits, the tax burden on direct real estate investments would substantially increase, making direct property investment less attractive.An investor deciding between purchasing a physical property or investing in a REIT might now lean towards the latter. The shortened holding period and the 12.5% tax rate on long-term gains for REITs offer a more straightforward and potentially lucrative investment opportunity. Earlier, before the union budget, the taxes on REITs were higher and also used to come with longer holding periods.The combined effect of these changes encourages a shift in investor preference from direct real estate to REITs.3.1 A ComparisonHere’s a comparison highlighting the differences between REITs and Direct Property Investment from the perspective of Short-Term Capital Gains (STCG) Tax and Long-Term Capital Gains (LTCG) Tax under the new taxation rules:AspectREITsDirect Property InvestmentHolding Period for LTCG12 months24 monthsSTCG TaxTaxed at the investor’s applicable income tax rateTaxed at the investor’s applicable income tax rateLTCG Tax Rate12.5%12.5%Indexation BenefitsNot applicablePreviously available, now removedLiquidityHigh due to stock market tradingLow due to longer sale processes, high ticket price, etcMinimum InvestmentGenerally lower, allowing fractional ownershipGenerally higher, requiring substantial capitalTransaction CostsLower (brokerage fees, etc.)Higher (registration fees, stamp duty, etc.)ManagementProfessional management by REIT companiesSelf-managed or through property managersIncome GenerationComparatively, Higher Rental YieldComparatively, Lower Rental Yield[Note: As of today, the dividend yield of Embassy Office Parks REITs is about 5%. Comparatively, if we buy a residential property in a Tier-1 city in India, its starting rental yield will hardly touch 3.5%.]ConclusionThe changes to LTCG rules for REITs enhance their appeal. The holding period is now 12 months, and the LTCG tax rate is 12.5%. These changes increase liquidity and flexibility for investors. REITs now compare favourably to direct property investments, especially with the removal of indexation benefits.The positive outlook for REITs suggests strong growth ahead. Investors should consider REITs for real estate exposure. They offer professional management and lower capital requirements. These adjustments make REITs a dynamic and accessible choice.Suggested Reading:
