REITs vs REIT mutual funds vs direct property: Which real estate investment offers better tax treatment?

Today, investors have three broad ways to invest in real estate. They can buy a property directly, invest in listed Real Estate Investment Trusts (REITs), or choose mutual funds that invest in REITs. All three offer exposure to the real estate market, but they differ widely in terms of investment amount, liquidity, returns, risks, and taxation. 

While factors like rental income, capital appreciation, risk appetite, and tenure often drive the decision, the tax treatment of all these three options is quite different, resulting in varied overall gains.

Three ways to invest in real estate 

Direct property investment 

This is the traditional way of investing in real estate. You buy a residential or commercial property in your own name and earn returns through rental income, capital appreciation or both.

While direct ownership gives you complete control over the asset, it also requires a larger investment and comes with responsibilities such as maintenance, tenant management and paperwork.

This is the traditional way of investing in real estate. You buy a residential or commercial property in your own name and earn returns through rental income, capital appreciation, or both.

While direct ownership gives you complete control over the asset, it also requires a larger investment and comes with responsibilities such as maintenance, tenant management, and paperwork.

REITs 

A REIT is an investment vehicle that owns and manages income-generating commercial real estate such as office buildings, shopping malls, business parks, and other leased properties. 

Investors purchase units of a REIT, allowing them to participate in the rental income and potential appreciation in property values without directly owning or managing real estate.

Publicly available REIT units are listed on stock exchanges and can be bought and sold like equity shares, making commercial real estate significantly more accessible and liquid for investors.

REIT mutual funds

Until now, mutual fund investments in REITs existed in a regulatory grey area, often bundled into hybrid or miscellaneous categories. SEBI’s circular of November 28, 2025 changes that effective January 1, 2026, REITs will be formally classified as equity-related instruments for mutual funds and Specialized Investment Funds (SIFs).

Recent changes in REIT mutual fund rules

REIT mutual funds have recently become a more clearly defined investment category.

Under SEBI’s circular dated November 28, 2025, effective January 1, 2026, REITs have been classified as equity-related instruments for mutual funds and Specialized Investment Funds (SIFs). Earlier, REIT investments often existed within hybrid or miscellaneous fund categories.

REIT investments already held by debt mutual fund schemes as of December 31, 2025 have been grandfathered. SEBI has, however, encouraged fund houses to gradually reduce such holdings where market conditions permit.

“Looking ahead, REITs are also set to join equity indices from July, 2026, under a phased rollout. This should enhance their visibility, attract greater institutional interest, and potentially improve trading liquidity over time,” said Thomas Stephen, Director & Head – Preferred, Anand Rathi Shares and Stock Brokers.

How are REITs taxed?

REIT investors generally receive returns in different forms, including interest, dividends, rental income and capital distributions. Each component is taxed differently.

Under Section 223 of the Income-tax Act, 2025 (corresponding to Section 115UA of the Income-tax Act, 1961), these distributions generally retain their original character.

Interest and rental components, as well as dividends from a Special Purpose Vehicle (SPV) that has opted for the concessional corporate tax regime, are generally taxable at the investor’s applicable income-tax rate. Certain dividend components, however, may remain exempt.

Capital distributions are governed by Section 92(2)(k) of the Income-tax Act, 2025.

Listed REIT units become long-term capital assets after a holding period of 12 months. Short-term capital gains are taxed at 20% under Section 196 of the Act, while long-term capital gains exceeding the aggregate threshold of Rs 1.25 lakh are taxed at 12.5% under Section 198.

How are REIT mutual funds taxed?

The tax treatment of a REIT mutual fund depends on how the mutual fund itself is classified under the Income-tax Act. Simply investing in REITs does not automatically qualify the scheme for equity-oriented taxation.

For investors, equity-oriented tax treatment is available only if the scheme independently satisfies the requirement of investing at least 65% of its portfolio in equity shares of domestic companies.

“Accordingly, the taxation of a REIT-investing mutual fund would continue to depend on its actual portfolio composition and whether it qualifies as an equity-oriented, specified debt, or other mutual-fund scheme under the Income-tax Act. SEBI’s classification of REITs as equity-related instruments does not automatically result in equity-oriented tax treatment; the mutual fund scheme’s actual portfolio composition and satisfaction of the prescribed statutory thresholds would need to be examined,” says CA (Dr.) Suresh Surana.

How is direct property taxed?

Buying a property directly follows an entirely different tax structure.

If you earn rental income, it is taxed under the head “Income from house property.” Investors can claim a standard deduction of 30% on the net annual value after deducting municipal taxes. Interest paid on eligible home loans may also be claimed as a deduction, subject to the provisions of the Income-tax Act.

When the property is sold, capital gains tax depends on the holding period and the date of acquisition.

For immovable properties acquired on or before July 22, 2024 and sold on or after July 23, 2024, resident individuals and Hindu Undivided Families (HUFs) can choose whichever results in a lower tax liability—20% tax with indexation or 12.5% tax without indexation.

This grandfathering benefit is not available to companies, LLPs, partnership firms, non-residents or properties acquired on or after July 23, 2024. Such properties are generally taxed at 12.5% without indexation.

Direct property ownership may also qualify for certain capital gains exemptions on reinvestment under Sections 82 and 85 of the Income-tax Act, 2025.

Which option is more tax-efficient?

REITs may suit investors looking for lower investment amounts, better liquidity and a shorter holding period for long-term capital gains. REIT mutual funds offer another convenient route for investors who prefer the mutual fund format and professional portfolio management.

Direct property, on the other hand, may be more suitable for investors who want to own a physical asset, earn rental income and take advantage of deductions such as the 30% standard deduction, eligible interest on borrowings and certain capital gains exemptions.

Ultimately, the better option depends not only on tax treatment but also on your investment goals, holding period, cash flow requirements and overall financial situation.

Disclaimer: This article is for informational purposes only and does not constitute professional tax advice. Tax laws and regimes are subject to frequent changes by the government. Readers should verify details with official Income Tax Department notifications or consult a Chartered Accountant before making any financial decisions.  

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