Many private equity real estate investments are organized as partnerships or limited liability corporations (LLCs) taxed as a partnership. In a partnership, the business itself files a Form 1065 tax return while individual partners claim business profits and losses on their individual tax returns. Each partner’s share in the business is reported on the IRS Schedule K-1 form.
As a private equities real estate investor, there are five main sections of the Schedule K-1 tax form you need to understand: (1) taxpayer, ownership, and loan information, (2) your capital account analysis, (3) income-related boxes, (4) capital gains- and depreciation-related boxes, and (5) miscellaneous boxes. The most important sections to passive investors are usually the capital account analysis including distributions in box L, the partner’s share of rental income in box 3, and the boxes that relate to capital gains (boxes 9-10) in the year of sale.
It’s important to delineate the differences between your K-1 information throughout the asset’s hold period and the information that will be needed the year the property is sold. We are using general language throughout the entirety of this article but will do our best to note when there will be specific caveats.
It’s also important to note that the amounts reported on the K-1 flow to the individual’s tax return and will have different effects for different investors based on their particular circumstances. As always, please consult with a tax professional before filing any tax forms.
Taxpayer, Ownership, and Loan Information
Items A-C: This is your partnership’s Employer Identification Number (EIN) and contact information, and identify which IRS filing center the K-1 will be sent to.
Item D: Not applicable to private equity partnerships.
Item E: This is your Taxpayer Identification Number (TIN), which can be any of the following: social security number (SSN), individual taxpayer identification number (ITIN), or employer identification number (EIN).
Items F-I: Note your contact information, partner status, and foreign or domestic status.
Items H2-I2: Not applicable to private equity partnerships.
Items J-K: This section shows your share of the partnership’s profits, loss, capital, and liabilities (sorted by recourse, qualified nonrecourse, and recourse).
Your Capital Account Analysis
As of 2020, partnerships are now required to report each partner’s capital account on a tax basis, which is NOT their capital contribution balance or asset basis. For the duration of asset ownership, this will detail your contributed capital plus income minus distributions. In the year the asset sells, this will end in zero after all distributions are made by the sponsor.
Item L: This shows the amount of contributed capital in the year plus income and minus distributions. Generally speaking, a partner’s tax basis capital account balance is increased by items such as contributions, rental income, sales profits, etc.; it is decreased by items such as distributions, withdrawals, losses (including depreciation), etc. Note that the capital account balance shown here for tax purposes is not usually the basis of your investment for the calculation of preferred returns and other investment-related metrics.
Item M: While this is typically irrelevant to most passive investors, check “yes” here if you contributed property with a built-in gain or loss to the partnership this year, defined as “the difference between the fair market value of the property and your adjusted basis in the property at the time it was contributed to the partnership.”
Boxes 1-7 (Income)
1. Ordinary Income: Usually $0 for limited partners; sponsors may accrue ordinary income through management fees
2. Net Rental Income: Income minus depreciation and other expenses; can be active or passive per your designation
3. Other Net Rental Income: Is passive income for all taxpayers; not likely to be used as this income will simply be reported in box 2
4. Guaranteed Payments: $0 for limited partners; in rare cases, sponsors may have a guaranteed salary
5. Interest Income: Usually $0 unless participating in a debt-related syndication or fund
6. Dividends: Usually $0 barring any special circumstances; most limited partnerships do not distribute dividends unless you are investing in a private real estate investment trust
7. Royalties: $0; royalties are highly unusual in real estate
Boxes 8-13 (Capital Gains & Depreciation)
- Net Short-Term Capital Gains: $0 if the asset is held for longer than one year.
9a-b. Net Long-Term Capital Gains: $0 until the asset is sold and is held for more than one year.
9c. Unrecaptured Section 1250 Gain: $0 until the property is sold, this is depreciation recapture taxed at 25% when the property is sold (applies only to straight-line depreciation, not accelerated depreciation; accelerated depreciation is recaptured at ordinary rates).
- Net Section 1231 Gain: $0 until the property is sold; these are real or depreciable assets held for more than one year, taxed at capital gains rates; this is where gains will be reported upon sale
- Other Income: Any reportable losses or income that doesn’t fall in the interest, ordinary dividends, royalties, or capital gains categories (see instructions on page 2 for details and special codes)
- Section 179 Deduction: Immediate deduction in the first year of purchase for expenses related to depreciable assets such as equipment, vehicles, and software
- Other Deductions: Here you’ll use the codes and instructions on page 2 of the Schedule K-1 to report any other deductions you’re claiming. This may include cash and noncash contributions, educational assistance benefits, pensions, and IRAs.
- Self-Employment Earnings (Loss): Use this box to report any self-employment earnings (or losses).
- Credits: Use the codes and the instructions on page 2 to report your share of any credits you’re claiming (e.g., the low-income housing credit or the disabled access credit).
- Foreign Transactions: Report your share of any income or losses incurred through any foreign transactions.
- Alternative Minimum Tax (AMT) Items: Enter any relevant Alternative Minimum Tax (AMT) information.
- Tax-Exempt Income and Nondeductible Expenses: Report any tax-exempt income or nondeductible expenses.
- Distributions: Report any distributions you received from the partnership (e.g., cash, marketable securities, property).
- Other Information: Report any other information here using the codes and instructions on page 2.