There is this time of the year…once a year…every year…when you feverishly scramble to put the package together and then await the outcome and score on how well you did and either pay up if you were naughty or get paid if you were nice! No we are not talking about Santa Claus and Christmas J Even though they are somewhat alike, we are referring to annual tax filing season when you scramble to put together the reporting package for your CPA and anxiously await the outcome – will you receive a refund or will you have to pay?

If you are investing passively, you have hopefully selected an investment with a cost segregation feature that would have ability to bring forward a substantial amount of the depreciation in year one to effectively defer taxes. But how do you know how you did? And how do you navigate through the complexities of reading the K1 you receive from the sponsors.

In today’s quick snippet, we’ll demystify just that. Needless to state, we’d be sharing a general example, i.e. as always you must consult with your CPA and tax advisor re your individual situation.

To begin with, let’s take a step back and clarify what the K1 is. Typically entities with more than one partner complete form 1065, or a partnership tax return. The K1 form is part of that return and reflects your share of the partnership activity. The partnership itself does not pay taxes. The partners do, based on their individual share.

Part 1 of the K1 will typically list the partnership entity. In a syndication, this would be the entity you are a member of.

Part 2 will show your individual information.

It is important to review and double check it for accuracy. Specifically you want to ensure that Clauses E and F, i.e. the entity information and TIN are correct if you are investing via a legal entity (or your name and SSN, if investing as an individual).

Clause J will reflect your investment share as % of the total partnership.

Clause K will show your share of the debt, to the extent you are one of the signers and/or guarantors on the loan.

Clause L will show your principal investment amount, which amount will/should match your principal investment. For example, if you invested $100K, it will be shown there. Your current year loss will be reflected here too, thereby arriving at your ending capital account balance. This balance is one you want to track closely over the lifecycle of the deal. It will ultimately show the capital payable to you at the conclusion of the deal.

Lastly, if you are investing via a retirement account, Part 2 I2 box will be checked.

Part 3 will show your share of the income and loss and any other income. Items 1 shows non-rental income (e.g. lending), 2 – rental real estate income, 3- rental non-real estate income (e.g. equipment leasing). It is important to consult with your CPA on how that information will flow into your tax return because the nomenclature here can be a bit misleading. For example, even though clause III 1 is labeled as “ordinary income/loss”, it might still be passive for tax reporting purposes (e.g. if you were an LP in a syndication). And vice versa – just because rental income/loss is reported in box III 2, it does not automatically mean it is passive (e.g. if you qualify as a real estate professional).

It is not uncommon for boxes 1 or 2 to show a loss in year 1 and 2 of operations, especially if the investment is eligible for cost segregation and bonus depreciation. This is one of the tax deferral benefits of investing in real estate syndications – even though the investment was profitable, the paper losses from depreciation reduce/eliminate the tax liability for that tax year thereby reducing one’s effective tax rate.

Any distributions received throughout the year will be reflected in box III 19 and any interest income in box III 5.

Partnership tax returns and as such K1s are due by no later than 3/15. However, it is not uncommon for the partnership to file an extension, in which case the K1 may arrive after 3/15. Speaking from personal experience as an LP, there have been times when I received my K1s in July-August. Thus, I usually file a personal tax return extension. If extended the final personal tax return is due by 10/15. However, your CPA must still do a prelim estimate of the tax liability at the time of the extension and if tax is due, it will be paid by 4/15. Any refunds or adjustments will be settled at the time of the final return filing.

K-1s income/losses are subsequently reported on Schedule E of your personal tax return. This is where you will see the various K1 line items (non-passive and passive) listed.

We are not tax advisors or CPAs, i.e. it is always best to consult with your re your individual circumstances. However, we hope this high level synopsis was helpful to clear up some of the confusions around K1s, their significance, how and where they fit in the overall tax documentation and the key sections to focus on when you review yours.

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Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.