Consolidated K1s and state income taxes
Most Popular Reply
Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votesThis problem has been discussed here on the forum many times, never producing any consensus between tax professionals.
Let's say your fund invests in 6 states.
State #1 - no state tax
State #2 - your home state
State #3 - state that allows a composite return, you opted in
State #4 - state that allows a composite return, you opted OUT
State #5 - state allows a composite return, but the sponsor does NOT offer them
State #6 - state that DOES NOT allow a composite return
You will receive a Federal (IRS) K1 plus five state K1s, for states #2-6 (no K1 for state #1, since it does not have state-level tax)
State #1 - no issue
State #2 - you do NOT want a composite tax return for your home state, since you must file you home state tax return anyway, and composite will mess it up
State #3 - no issue, they will take care of your state exposure
So the problem is states #4-6: either no composite returns allowed, or the sponsor does not bother with them, or you choose to opt out. It becomes your responsibility to file three non-resident state tax returns.
Biggest problem: Each state has its own rules about whether or not you must file with small K-1 amounts. These rules are very confusing and inconsistent. Tax professionals disagree on this issue.
Let's assume you determined that state tax returns ARE required for these three states. Your options are:
A. Let your CPA file them, and yes, it's expensive (typically $100-500 per state) even if your income for each state is small
B. Roll a dice by not filing these three states and hope the states will not pursue you
C. Stay away from this investment altogether
10 Replies
- 3yGreg ScottPro MemberRental Property Investor · SE Michigan · Member since 2014 · 4k+ posts · 6k+ votes
My understanding is you are responsible for your filing, and I don't see how a "consolidated K1" could save you anything. A good CPA will do the math to see if you really owe something or if you should file a return in each state to get your money back.
On the other hand, if the deal doesn't make sense because of your CPA fees, that is a horrible deal. You shouldn't invest in it anyway.
Interesting... partnerships and K-1 I thought were pass-through entities. The 1065 will the filed "everywhere." You need to file a matching return(s).
With a "consolidated k-1" perhaps they are saying the fund it taxed, that would save you from filing and getting a k-1. The representative may just not know correctly and just trying to sell you on the fund.
If filing in a few additional states is going to kill your profit, then perhaps this isn't a good investment or your cpa is too expensive.
- Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes3y
@John P.
I applaud you for the due diligence you are doing on this. Far too many people just look at gross projected returns on a fund and are like wow I want that but don’t understand the tax consequences they are going to be subjected to and where they are on a net return.
True story my wife hounded me so much about k-1’s (from my investments and from my own funds) that I only do funds now that are corporations so I don’t have to deal with k-1’s.
Happy wife happy life
7e investments53 Reviews - 3yBasit SiddiqiBusiness MemberAccountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
I think you mean to save "Composite" return instead of "Consolidated"
Composite when dealing with a real estate fund may be a bad idea because you can potentially be forgoing all the suspended losses and therefore paying tax on the net gain at the end without factoring in past losses.
How much is your CPA charging for each additional state return to be filed?
Best of luck.
Basit Siddiqi CPA4.979 Reviews Quote from @Basit Siddiqi:
I think you mean to save "Composite" return instead of "Consolidated"
Composite when dealing with a real estate fund may be a bad idea because you can potentially be forgoing all the suspended losses and therefore paying tax on the net gain at the end without factoring in past losses.
How much is your CPA charging for each additional state return to be filed?
Best of luck.That makes sense. However, they could do a composite return at the state level but not the fed? Not a big deal at the state level.
He charges too much and didn't give me a firm number. He said less than $500 per state. That is enough that if I only invest $100k or $200k it's not worth getting into additional state returns... hence my dilemma.
"However, they could do a composite return at the state level but not the fed?" At the Federal level, what other taxation are you expecting to the lumped together?
the point of the state level grouping, as I understand, is that each partner doesn't have to file their own returns. One trades off the costs/headaches of the individual filings vs. potentially being less tax efficient.
- 3yMichael PlaksPro MemberTax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
This problem has been discussed here on the forum many times, never producing any consensus between tax professionals.
Let's say your fund invests in 6 states.
State #1 - no state tax
State #2 - your home state
State #3 - state that allows a composite return, you opted in
State #4 - state that allows a composite return, you opted OUT
State #5 - state allows a composite return, but the sponsor does NOT offer them
State #6 - state that DOES NOT allow a composite return
You will receive a Federal (IRS) K1 plus five state K1s, for states #2-6 (no K1 for state #1, since it does not have state-level tax)
State #1 - no issue
State #2 - you do NOT want a composite tax return for your home state, since you must file you home state tax return anyway, and composite will mess it up
State #3 - no issue, they will take care of your state exposure
So the problem is states #4-6: either no composite returns allowed, or the sponsor does not bother with them, or you choose to opt out. It becomes your responsibility to file three non-resident state tax returns.
Biggest problem: Each state has its own rules about whether or not you must file with small K-1 amounts. These rules are very confusing and inconsistent. Tax professionals disagree on this issue.
Let's assume you determined that state tax returns ARE required for these three states. Your options are:
A. Let your CPA file them, and yes, it's expensive (typically $100-500 per state) even if your income for each state is small
B. Roll a dice by not filing these three states and hope the states will not pursue you
C. Stay away from this investment altogether To expand the discussion, for those among us who are evaluating funds to invest in, but want to avoid the tax preparation cost of multiple state tax returns, the following article talks about the benefit of a private equity fund structured as a REIT. Per the author, the REIT structure eliminates the need for multiple state tax filings at the investor level, as well as eliminating UBTI.
As someone who has learned the hard way about multi-state tax filings and composite returns, I want to avoid those in the future, and since I'm currently looking at QOF's I welcome comments about fund choice based on how it is structured.
- 3yMichael PlaksPro MemberTax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
Quote from @Wayne C.:
To expand the discussion, for those among us who are evaluating funds to invest in, but want to avoid the tax preparation cost of multiple state tax returns, the following article talks about the benefit of a private equity fund structured as a REIT. Per the author, the REIT structure eliminates the need for multiple state tax filings at the investor level, as well as eliminating UBTI.
Yes, you will be receiving dividends instead of K-1, so no state reporting hassle. However, this is the tail wagging the dog. When evaluating investments, I always preach these priorities:
1. Does this investment fit my overall business plan?
2. How profitable is this investment?
3. What are the risks of this investment?
4. Tax considerationsI will always disagree with investors prioritizing #4 above the other, more important, criteria.
Also, I'm confused with you mentioning UBTI. If you're concerned about UBTI, then you must be considering investing via your self-directed retirement accounts. But SDIRAs are not subject to the state reporting requirements that we're discussing here. If you're investing via SDIRA, you should not worry about states, and this particular advantage of REITs (no state reporting) is irrelevant.
- Thank you, Michael. I'm not able to strictly prioritize your criteria in that order for every investment. Surely, any investment must fit one's plan, and risks can be logically evaluated, but a certain profit cannot be accurately calculated..it's always a gamble in real estate. It just seems to me that the cost of tax compliance can be a high priority, especially for a likely 10 year hold QOF. Engaging a tax pro year after year for multi-state returns has the same impact on profit as the fees that are charged by the fund sponsor.
Quote from @Michael Plaks:
Quote from @Wayne C.:
To expand the discussion, for those among us who are evaluating funds to invest in, but want to avoid the tax preparation cost of multiple state tax returns, the following article talks about the benefit of a private equity fund structured as a REIT. Per the author, the REIT structure eliminates the need for multiple state tax filings at the investor level, as well as eliminating UBTI.
Yes, you will be receiving dividends instead of K-1, so no state reporting hassle. However, this is the tail wagging the dog. When evaluating investments, I always preach these priorities:
1. Does this investment fit my overall business plan?
2. How profitable is this investment?
3. What are the risks of this investment?
4. Tax considerationsI will always disagree with investors prioritizing #4 above the other, more important, criteria.
Also, I'm confused with you mentioning UBTI. If you're concerned about UBTI, then you must be considering investing via your self-directed retirement accounts. But SDIRAs are not subject to the state reporting requirements that we're discussing here. If you're investing via SDIRA, you should not worry about states, and this particular advantage of REITs (no state reporting) is irrelevant.
Regarding UBTI, you are correct that it is only a concern within a SDIRA investment. I only mentioned it because it was mentioned in the article I linked to, and has been a topic of discussion in this forum.
Join the conversationCreate a free account to reply, vote on answers and follow this thread.