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Last Updated : June 18, 2024

OA 03: Frequently Asked Operating Agreement Tax Questions by GPs & LPs with Kaylyn Deaver, CPA

In this third episode of our series on operating agreements, Thomas is again joined by Kaylyn Deaver, CPA, a Tax Manager here at The Real Estate CPA! Thomas and Kaylyn discuss FAQs regarding operating agreements from listeners.

This episode is sponsored by our free Tax Smart Investors Facebook Group.

Full Transcript:
This podcast has been transcribed using AI, please excuse spelling, grammatical, and other errors.

Brandon Hall 0:00
You’re now listening to the real estate CPA podcast, your source for all things real estate, accounting and tax. Here we reveal our secrets that can save you 1000s in taxes, streamline your accounting process and help grow your business. Stay tuned to hear insightful interviews with industry experts, successful real estate investors and current clients on what strategies they use to grow their business, and how they steer clear of Uncle Sam.

Thomas Castelli 0:30
Hi, everybody. Thanks again, for tuning in. We are back with Caitlin as promised for our operating agreement, q&a episode. And we have a handful of questions here. And we’re going to go down one by one. So Kailyn thanks again for coming back.

Unknown Speaker 0:43
Yeah, Tom, thanks for having me. It’s a pleasure to jump on here and talk about operating agreements a little bit more.

Thomas Castelli 0:48
So the first question is, can you allocate a different portion of the cost segregation, aka that appreciation, basically, between the class A, B and C interest holders?

Unknown Speaker 0:57
Yeah, you can especially allocate depreciation, I would say that’s the most common thing we see specially allocated is depreciation, amongst the different levels of interest in a partnership. So yeah, allocating between A, B, and C, you can really break it up. However, you would like to just work with your attorney, you know, to make sure that spelled out very clearly and make sure that your limited partners are 100% sure of the depreciation that they’ll receive, because a lot of times those LPs are counting on the depreciation in the first few years to give them passive losses. So just make sure everyone’s clear on what they’ll be allocated, the portion that will be allocated to them. But absolutely, you can specially allocate depreciation, and it’s something we see pretty frequently.

Thomas Castelli 1:46
Yeah. And just to kind of comment on that, as well, I know there’s a lot of investors out there who will specifically invest in real estate syndications as a limited partner strategically to get a certain amount of depreciation for the year. So it is something that, you know, if you’re a limited partner, you’re going to want to look at the operating agreement, and see what you’re being allocated and make sure that it aligns with your overall investment objectives, including the tax benefits, you’re cheap. And for general partner that they’re like you instead, it’s just something you’re going to want to keep in mind that that could be a potential selling point of your investment. And by maybe not allocating it to limited partners, you might you might lose some interest, I guess it’s important to know who your investors are and what they’re looking for. Now, I’m not sure if you know the answer this question or not, but we do see, some people ask about the self directed IRA investors. Because, as you know, if you’re investing through a self directed IRA, you’re not subject to you know, ordinary income tax rates the way you are, although there’s something called viewbid that you that self directed IRA investors might be used for, would there be any issues with say, allocating this all away from the self directed IRA, group of investors you have a guest with that would presumably, presumably be under one class of investor.

Unknown Speaker 3:04
So from the partnerships perspective, as long as that allocation has substantial economic effect, you know, there’s no complications for the partnership itself. I personally don’t deal with too many self directed IRA. So I can’t speak to that part. But ultimately, as long as your allocation has substantial economic effect, and you know, work with your attorney and your CPA, to determine that you can allocate depreciation any way you want, it might be easier if you’re trying to allocate depreciation away from those self directed IRAs to group them all into one class in the partnership. I personally have not seen an operating agreement that just says specifically that no allocation will be made to self directed IRAs. So I think lumping them in with a separate class would probably be a better route to go if that was your intention. One thing I did want to mention, Tom with this question is something to consider when you’re specially allocating expenses such as depreciation, you have to be aware of the recapture that’s going to have to be paid when the property is sold, that depreciation that is specially allocated, the recapture will be allocated to those partners as well.

Thomas Castelli 4:20
100% and something for a lot of investors out there to be aware of is that the chickens do eventually come home to roost. So if you do take it, a very large amount of depreciation, that’s, you know, again, that’s not in line with the percentage interest, I could cause issues for you down the line, just something to be aware of make sure that you have a full understanding of how that’s going to impact your tax situation with your CPA. So we do have another question here. I’m not sure if this is necessarily an operating agreement question per se, but it’s kind of along the same lines and came in with a group of questions. And that is, in what state do you have to file a k one is it the state where the property is or the state where The owner lives were their state of residence. Yeah, we

Unknown Speaker 5:03
see this question pretty frequently, especially with partnerships that have many investors. I mean, we’re talking 1020 100 Plus investors. And ultimately, it all comes down to where your property is located and where your investors are located. So there’s no black and white answer here. And the reason for that is each state has different state laws and jurisdiction laws. To start with, you will file a k one in the state that your property is located. You know, unless you have property in Florida, where there’s no state income tax, you’re not passing a Florida k one to your investors at that level, then, so your k one will first be located to the state that the property is located in. So if I have a property in Georgia, I’m going to distribute a Georgia k one to my investors. But where things get extra tricky is also where your investors are located. So California, for instance, has a rule that if you have a GP in California, although my property is in Georgia, I also have to issue a California k one and I have to file a California tax return. Now, my investors aren’t going to be taxed in California, they don’t need to file a California tax return. It’s solely for this one investor, who lives in California so that he has a California k one. So if you’re an investor, you’re an LP a GP, whatever you may be in a partnership and you receive multiple state k ones, don’t panic, it’s not likely that you’re going to be taxed in all of those states, because odds are the property itself is only located in one state. You know, things get a little complicated when you have multiple properties in multiple states. But generally, if it’s just a one property partnership, you know, you’re only going to be filing taxes in that one additional state, in addition to where you currently live,

Thomas Castelli 6:57
God God so you know, generally speaking, they’re going to file a k one in the state where the property is located. And then they’ll have to file their K one in the state of residence where they live, of course, because that’s where they ultimately pay income tax. And, you know, there’s some credits out there for a breeze listening, I know what you’re thinking, you don’t have to pay tax in two states, generally speaking, usually, one state will issue a credit for the income taxes paid for the other state, but it’s just something to keep in mind. And that’s how it generally works. Any other comments? Kailyn, you have on this particular question?

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Unknown Speaker 7:30
Yeah. One other thing I wanted to note here about state k ones was when a state k one is passed to you, if there is income sourced to that state on your k one, you do have a filing requirement in that state. So like I mentioned previously, you might receive multiple K ones for multiple states, but you likely will not have a filing requirement in each state. And one other thing that I wanted to add there is, when you have a loss passed to you on a state k one, it’s important if you plan to recognize that loss of later, even if you have even if you’re a passive investor. So you’re an LLP. And you can’t take advantage of the losses right now, if you want to use those losses in the future to offset your state tax liability, when that property sells or when it’s generating income, you have to go ahead and start filing those state returns, so that those losses are carried forward. Because if you don’t file it’ll, it’s just a lost loss.

Thomas Castelli 8:29
Yeah, you know, it’s funny, because, you know, I get a lot of questions about that from from limited partners who invest, you know, they get all these k ones, like, Oh, my God, do, I really have to file a state tax return for it. And, you know, it really just depends, you know, when you’re in a loss position, of course, but I think it really depends on the size of those losses, and how important they would be to carry forward to give you an example, I had a k, when I received recently, from a state, I’m not gonna tell you what state it is, but the loss is very low. And I did all the math on it. And after, after doing the math, it was only going to save me a few bucks. So I decided, You know what, I’m not going to file the state k one, because it’s just too much of a hassle at that point to do it. So I just skipped it. But I mean, if they’re sizable losses that are being passed through, you’re definitely gonna want to file that because you’re leaving money on the table. In the future, if you if you don’t if you don’t end up doing those losses, because you can’t just group them all together. That’s another question. I get a lot actually from clients. Can you group all these losses together on 1k? One from all these years? No, you have to like Kailyn said you have to file the k one with the loss in the year that the loss is reported on your k one, in order to claim those in the future something very important to keep in mind.

Unknown Speaker 9:38
Absolutely. And Tommy, you bring up a great point here about not filing a k one and you know I mentioned pretty pretty heavily earlier that you have to file if you have income on that k one. And when you when you have a loss, typically you are still required to file but as Tom mentioned, there is a cost benefit analysis there. And so work with your CPA to determine is it worth it to file in this state? You know, we have charts and calculations that will model out if the benefit is worth the cost of filing that return.

Thomas Castelli 10:12
But on to the next question. So only if the preferred return stay in the agreement, would it be treated as ordinary active income? And if the returns are above the stated percentage, would they be cat categorized as passive losses? For instance, if there was a preferred return of 6%, and the return ended up being 10%? Would the 6% show up on the key one as ordinary income? And the end the rest? Be? Not not the not show up that way?

Unknown Speaker 10:43
Yeah. So to summarize that, Tom, because that was that was a loaded question there. I think what you’re asking is, the guarantee payment part that we talked about last week, you know, is treated as ordinary income subject to your ordinary rates. And if you have a 6% stated preferred return, that’s treated as a guaranteed payment. But ultimately, as an investor, you’re past 10% of the profits for the year, will your k one show the 6%? Or the 10%? And the answer to that question is in the box that shows guaranteed payments, it will show the 6% stated preferred return amount, and then the additional profit that you were allocated will be in box to where your net rental real estate income and loss is. So only that portion of the guaranteed payment that 6% is going to be subject to the ordinary rates, and everything else will be displayed in box to

Thomas Castelli 11:40
go guy now that’s important understands only the preferred return being categorized as a guaranteed payment, not the not the entire return necessarily from the investment. Alright, and we have one more question. Here’s a legal question. So we’re just gonna, I’m just gonna read the question. But you’re also gonna have to speak to your attorney about this one, just something for everybody out there who is listening, whenever you’re doing an operating agreement, there are legal portions, and then there are accounting and tax portions and usually your accountant, your CPA can help you with the accounting and tax portions of that operating agreement, but they’re not going to be will help you with the legal portions. And that question was, can you have different classes of units in order to have unit holders that don’t have any voting rights in the LLC? So the answer to that question is, we’re not 100% Sure. And even if we didn’t know the answer, we wouldn’t be able to provide you that because we’re not attorneys. So again, just something to keep in mind when you are working on these things. You do that you definitely want to have a team in place, including an attorney, believe it or not, that was actually all the questions were received in operating agreements. If anybody has any more, always feel free to send him a contact at the real estate CPA COMM And if we get a ton of new questions, we might just do another episode at some point in the future. Because this is a very popular topic for general partners of syndications as well as limited partners. That’s definitely something that you want to understand. So just want to thank Kailyn so much going on again for the third episode, and I’m sure we’ll see Kailyn again in the future.

Unknown Speaker 13:04
Thanks, Tom. And thanks again for having me.

Brandon Hall 13:06
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