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December 18, 2023 | read

The Basics of Real Estate Syndication Tax

Thomas Castelli

In this article, we’ll be discussing the taxation of syndications from both a limited partner and general partner perspective. General partners typically receive some fees that the limited partners don’t, and those fees are taxed differently than the cash flow and sales proceeds that come out on the back end.

Discuss with your CPA to make sure you are using the right tax strategies and planning opportunities to reduce your taxes as much as possible.

General Partners

Generally, general partners receive an acquisition fee for their efforts in finding the property, obtaining equity and debt financing, assembling the team, and closing on the property. This fee typically ranges anywhere from one to three percent of the property’s purchase price and this fee is taxed as ordinary income and is subject to the self-employment tax. General partners also receive an asset management fee which is a fee charged for the ongoing management of the investment. The responsibilities typically include managing third-party property managers, investor relations, and other related tasks. Asset management fees are typically 1 to 3 percent of the gross collected rents and are also taxed as ordinary income and are subject to self-employment tax as well.

Some syndication opportunities have other fees such as refinancing fees, construction fees, or disposition fees. These fees are treated in a similar manner to acquisition and asset management fees and are also subject to that self-employment tax. General partners will also receive a portion of the cash flow from their interest in the investment. This portion of the cash flow will be taxed as passive rental income or loss depending on whether or not the investment generates a positive net income or a net loss. General partners will receive a portion of the sales proceeds upon sale. That portion of the sales proceeds will be taxed either as a short-term capital gain if the property is held for less than a year, or a long-term capital gain if the property is held for longer than one year. The general partners will also be subject to appreciation recapture tax on the portion of the depreciation attributable to their investment interest.

Limited Partners

Limited partners do not receive the same fees as general partners because, as a limited partner, you are not taking an active role in the day-to-day management of the property the same way the general partners are. Instead, you’re simply investing for a return on your investment. This usually comes in the form of cash flow which is taxed the same exact way it’s taxed for general partners, as passive rental income or a passive rental loss. Likewise, sales proceeds will be taxed as a short-term or long-term capital gain depending on how long the property is held. Limited partners will also be subject to depreciation recapture on their portion of the appreciation attributed to their investment percentage.

Partnerships are not taxed at the partnership level. Instead, partnerships are considered passed through entities and the income or loss generated by the partnership is passed down to the individual partners, who are taxed at their individual rates. If you’re a limited partner, this is good news because you can still receive the tax benefits of direct real estate ownership without having to deal with the headaches of day-to-day management. Usually, these benefits include passive losses that are generated from depreciation expense and allow you to offset your other passive income.

When it comes to filing taxes, whether your limited partner or a general partner, you receive your share of the income or loss on Form K-1 at the end of the year when the partnership tax return is filed.

Which Tax Strategies Should You Be Discussing With Your CPA?

If you’re a general partner in a syndication, and you do multiple syndications throughout the year, you’re going to want to talk to your CPA on how you can mitigate that self-employment tax on your asset management fees, on your acquisition fees, and any other fees that may be included in the syndication.

For limited partners, you’re going to want to work with your CPA to develop a plan on which syndications are the best ones for you to invest with based on your unique circumstances because not all syndication opportunities are structured the same way. Not all syndication opportunities to provide the same tax benefits and not all syndications will receive the same amount of cash flow or sales proceeds.

You need to work your CPA to get a holistic approach on how you can fit syndications into your overall investment and tax strategy.