When one files a straightforward W-2 return, the process is usually simple. For CRE investors who participate in LLCs, some extra planning is typically involved. One form in particular — the Schedule K-1 — plays a major role in preparing a personal tax return.
It's important to remember, however, that tax aspects of such investments can be complex and may differ depending on the property or offering and on individual tax circumstances. Neither Crowd Street or its affiliates offer tax or legal advice. Investors are strongly encouraged to seek advice from qualified tax professionals and/or legal experts regarding the tax consequences based on their particular circumstances.
This article outlines some key facts.
Schedule K-1 Basics for Real Estate Investors
LLCs allocate Net Rental Real Estate Income (Loss) according to the operating agreement. Generally, each investor’s allocation is governed by the profit-and-loss provisions in the LLC’s operating agreement. Sometimes it’s as simple as applying your ownership percentage to the LLC’s taxable income or loss. In other cases, the agreement allows partners to share profits and losses differently. Investors can refer to their operating agreement to understand how their allocation was determined.
A property may show positive cash flow while still generating a tax loss. Depreciation is the primary reason. Sponsors can further accelerate depreciation through a cost segregation study, which may be particularly valuable for multifamily properties and can materially affect tax outcomes.
Real estate basis changes from year to year. Unlike stock investments, where basis generally stays constant, basis in an LLC typically shifts annually. It increases with capital contributions, income and gain allocations, and liability allocations, and decreases with distributions and loss or deduction allocations. This matters because distributions are generally tax-free only to the extent of basis.
Passive losses can carry forward.
Generally, investors can use passive losses to offset passive income in future years, depending on their overall tax situation.LLC investors receive a Schedule K-1; REIT investors receive a 1099.
K-1 income reflects pass-through activity from the LLC. REIT dividends are reported on a 1099 and taxed as dividend income.Don’t overlook the state tax implications of your LLC investment. If the property is located outside your home state, there may be additional state tax and filing requirements.
Additional Tax Resources for Investors
Congress’s Tax Cuts and Jobs Act of 2017 (TCJA) implemented the most substantial tax reforms since 1986, and many of its provisions continue to shape how CRE investments are treated today.
Consult the following resources for more information:
