What is a K-1 and How is it Used for Taxes in Private Real Estate?
Businesses that operate as partnerships, such as an investment in private real estate with Origin, are designed to utilize pass-through taxation, which means that 100% of income and expenses flow through the corporation to the owners or partners. This is a good thing for tax purposes. Tax deferral, tax shields, and the favorable capital gains rate paid at sale are big advantages of investing in private real estate.
A K-1 is the tax form prepared for each individual investor that reports his or her share of income, losses, deductions, credits from the business and any contributions or distributions made during the year. It’s very similar to the 1099s one receives for interest and dividends from stock investments. The individual investor then reports this information on his or her tax returns. For example, if a business earns a taxable income of $100,000 with two equal partners, each partner can expect to receive a K-1 with $50,000 of income on it.
Important K-1 and Tax Filing Information for Origin Real Estate Fund Investors
Origin investors must keep the following points in mind regarding K-1’s and tax reporting:
Valuation. As elaborate as a K-1 is, it does not report the fair value of the investments and it simply reports the tax basis of the investment. The actual value is available for investors to view by logging in to our secure portal and looking at the net asset value.
Tax-Basis. The tax basis of a property starts with the original cost basis of the property. Over time, taxable income, capital contributions and certain loans to the partnership by third parties can increase the basis while depreciation, expenses and distributions can reduce it. The higher the basis, the lower the gain when the asset is sold.
Losses. A K-1 may show a loss due to non-cash deductions such as depreciation. It’s common in value-added real estate for losses to be incurred on the K-1 because these assets produce little to no income, but receive the benefit of depreciation. For example, if an asset generates $50,000 in net operating income and has a depreciation deduction of $150,000, the business would report a net loss of $100,000 for tax purposes. If there are two equal partners, each partner would receive a K-1 with a loss of $50,000.
Tax Deferred Distributions. Certain distributions provide tax deferral advantages, such as distributions made as a result of refinancing an existing property. Only income is taxed and this type of distribution is not classified as “income,” according to IRS rules. However, the tax basis will be reduced by the amount of the distribution and the investor will get caught up on taxes when the asset is sold.
K-1 Arrivals. Our goal is to send investors K-1s by the end of March.
The number of federal and state K-1’s received will also vary depending on the type of investment structure. Funds consolidate K-1’s into a single document so investors don’t have to file individual K-1’s for every property in which they have a beneficial interest. For example, if one person invests in a fund comprised of 20 properties and another person invests in 20 different individual deals, both individuals will have to file multiple state K-1s. However, the fund investor will only receive one federal K-1 and the individual deal investor will have to file 20 federal K-1s for each partnership.