Receiving tax benefits when investing in a syndication depends on multiple factors. The most common factors influencing your potential tax benefits are entity type, whether you share in the profits, the capital, or both, and whether you took an equity or debt stake.
Most syndicates are structured as LLCs. LLCs are extremely flexible entities and can have multiple classes of shares that investors own. These different share classes often carry different stakes in the entity’s profits and capital.
When you are an equity holder in an LLC, and you have a profits interest, you will receive a pro rata share of the entity’s profits and losses. This means you will be allocated a portion of whatever tax strategy the entity is utilizing. When an LLC files its tax return, it will claim all of the income and deductions and then issue you a Form K-1. That K-1 will be used to prepare your personal tax return and report your share of the entity‘s profits and losses.
When you are a debt holder, you will receive interest income from the entity. You will not share in the entity’s profits and losses meaning that you will not benefit from any tax strategies the entity it deploying.
It’s important to note that you will generally not pay taxes on funds distributed by the LLC unless that distribution exceeds your basis in the LLC. This is a common point of confusion as clients will receive $50k in distributions but the Form K-1 they receive shows a passive loss. In this example, the investor would not pay tax due to the loss reported on the K-1 even though they received $50k in distributions. These distributions would instead lower the investor’s basis in the entity and be considered a return of capital.
Have questions?
Our Tax Smart Investor Plus subscription includes Live Q&As where you can get your questions answered by our seasoned tax experts.
