Depreciation to some partners & not to others in same property.

10 Replies

A syndicator has told me they can give a better return to IRA investors as they don't need depreciation and her accountant does this type K-1 schedule. This would mean the people investing from their personal savings would get a bigger write off and less cashflow the way this is structured.

Other Syndicators get their cost segregation in place and then give a higher cashflow return to the equity partners. 

This sounds the opposite to me. And a confused mind says "NO". I need to be able to explain to potential partners.

As the real estate matchmakers for your financial freedom and a long time real estate investor, I like creativity.  If any CPA could give me the IRS code or supporting information, I would appreciate it.

If this is true, why aren't all the syndicators having their CPAs doing this type of accounting for their equity partners? 

It seems a great disadvantage at the time of sale to the investor who used personal funds as most syndicators do not 1031 to avoid taxes. This means all depreciation must be recaptured.

I thank you. 

@Peggy Beauregard

Here is why other CPAs are not doing this: it's probably breaking the rules. You cannot treat different partners in a syndication differently without economic substance, just because it gives favorable tax treatment to some partners.

It might be possible to structure things this way if different partners have different level of participation and different risks - which is case by case and high-end as far as tax planning goes. And not always possible.

@Peggy Beauregard

Obviously @Michael Plaks is correct (he knows his stuff!). Jokes aside, the partnership may have different treatment for different partners' classes and I deliberately said "may" because it is not by default rather depends on the partnership structure. You can read up more about it here: 

https://www.irs.gov/publications/p541

@Peggy Beauregard

There are no problems with special allocations of depreciation as long as those allocations have substantial economic effect as prescribed by IRC Sec 704(b) and the related regs.

"If this is true, why aren't all the syndicators having their CPAs doing this type of accounting for their equity partners?"

Because it's not a matter of GPs telling their CPAs to do something.  The operating agreement needs language to give allocations substantial economic effect and all partners must agree to the terms (the good, the bad, and the ugly).

Excellent answer.  Special allocations can be done (and are frequently) and are respected as long as they have substantial economic effect.

Originally posted by @Eamonn McElroy :

@Peggy Beauregard

There are no problems with special allocations of depreciation as long as those allocations have substantial economic effect as prescribed by IRC Sec 704(b) and the related regs.

"If this is true, why aren't all the syndicators having their CPAs doing this type of accounting for their equity partners?"

Because it's not a matter of GPs telling their CPAs to do something.  The operating agreement needs language to give allocations substantial economic effect and all partners must agree to the terms (the good, the bad, and the ugly).

 

Well, I said "economic substance" trying to avoid the technicalities. Which, of course, @Eamonn McElroy could not avoid. :) We're all saying the same thing. I'm in English, and Eamonn and my other colleagues in legalese.

What likely happened with that syndicator is arbitrary allocation without properly setting it up. And it's not OK. I've seen it often.

Thank you each for your comments. They were all very helpful. 

@Eamonn McElroy comment was the most helpful. "It must be in the operating agreement". I didn't know that was economic substance. I don't know what substance it is Michael Plaks and how one would show it to be substantial. Appreciate every comment. After these many years there is always something left to learn. Thank goodness. How could anyone know everything. Have a great weekend.


@Peggy Beauregard

Encourage you to work with your tax professional and business attorney to make sure partnership agreements and operating agreements accomplish what you and your investors want.

One could create an entire semester-long university class on just that one code subsection -- IRC Sec 704(b).  The amount of related regulations and case law is staggering.

@Peggy Beauregard I have seen in many cases the operating agreements give different treatment to the investors. As @Eamonn McElroy pointed out it must be done this way and depreciation cannot simply be distributed differently by the CPA.

If I recall @Brian Burke once mentioned that he has done this form of agreement, perhaps he could shed light on the specifics.

I have one friend/client (most of my clients end up being friends, if they weren't beforehand 😊) who as the GP gives all of the equity to his investors, and he only takes fees, and proceeds, thereby giving the investors all of the depreciation. This must be written into the operating agreement with all of the legalese necessary.

Originally posted by @Yonah Weiss :

 If I recall @Brian Burke once mentioned that he has done this form of agreement, perhaps he could shed light on the specifics.

In our operating agreements, all depreciation is specially allocated to the investors. Therefore they get the benefit of all depreciation on a pro-rata basis. As the investment sponsor, our "manager" class of LLC units do not get any portion of the depreciation. If we invest capital in the deal, our capital is the same class as our investor's units so we get our pro-rata share of depreciation for the capital invested.

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