I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox π Also on YouTube at PlugAccountingandTax!
Is this K1 even right? π 3 things to check on Real Estate K1s
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This is it. We've reached K1 season again π - where returns are rushed out before March 31 only to sit with the LP's CPAs until October 14th at which time all the questions come. But how can you, as either a LP, GP, or an advisor, look at the K1 in March and tell if something is off? π€·ββοΈ I'm glad you asked. Today, we're jamming on 5 things β to check when you first get the K1:
These usually drive 80% of the questions - and meaningful corrections - we get requests for well after the K1s are filed. Debt Classification and AllocationSpecifically, look in Box K1 of the K1 - and. yes, I realize how confusing that is β€΅οΈ This matters because in a partnership, your at-risk basis as a partner is increased by any allocated recourse or qualified non-recourse debt. We like at-risk basis because it can help tax liabilities π° by permitting losses and keeps distributions "tax-free." π§ We'll take each one separately:
The point here is to know what kind of debt the property has on it. π The allocation of recourse is usually in proportion to the guarantee provided. The allocation of qualified nonrecourse debt usually follows profit sharing ratios. Distributions and Contributions MadeFor this one, we move just one box down on the K1 to Box L β€΅οΈ These amounts should (in most cases) agree to the actual CASH you contributed or received as distributions. π¦ Distributions are provided to us by the GP from their investor spreadsheet and trackers. π¨βπ» We summarize them and make sure they tie back to the financials. But sometimes they don't tie for various reasons (timing, etc.). So help is always appreciated by the LP to confirm what they actually got (or didn't get). Contributions are also tricky - sometimes the commitment table in the operating agreement doesn't match what actually made it into the bank. π Look at these lines in the K1 and let the GP know if you have anything different. **Special Rule for Preferred Returns** - it's worth pointing out that payment of "pref" is many times classified as a guaranteed payment for use of capital (see Box 4b on the right hand side of the K1). So it may take some looking around for your distributions if it was pref payment. Ending Capital Account BalancesNow look just below the distributions line on the same Box L to the "ending capital account" line β€΅οΈ Usually this is a positive number. πΊ And if it's a negative number, you should have an amount in Boxes K1 for either recourse or qualified nonrecourse. βοΈβοΈ Rarely would there be a negative capital account with no associated debt allocated to that LP - and if there is it's at least worth talking to the GP's CPA to confirm that. π It may also be an indication of a tax return not following the operating agreement - especially when there are other LPs that have positive capital accounts. Won't get much further into the weeds, but this is a good thing just to confirm. π¨Reminder that I offer consulting-type reviews of operating agreements and tax returns (+K1s) as a quality check. I've done a lot of these and in 90% of cases find something worth looking further into. Just reply to this email - I read every single email.π¨ QBI AllocationsSo this one changes based on the type of K1 you're getting. Form 1065s have it in Box 20 Code Z, and 1120Ss have it in Box 17 Code V. We're looking at 1065 K1s so here's where it would be β€΅οΈ You need this information to be able to take the correct amount of QBI (qualified business income) deduction. βοΈ Over certain income amounts, you get phased out on how much QBI you can take. So we look through to the underlying K1s to pull allocated wages (W2) and asset basis (UBIA). π This box usually points us to a supplemental K1 statement, or states that this entity is a SSTB (specified service trade or business) and not eligible for QBI. The problem is not all software defaults to having W2 and UBIA carried into these boxes, so it takes some special entry that can be missed in a rush time of year. EINThis is the number you need to get right. Yes, we need names and addresses - but the EIN will cause a mismatch on transcripts and cause real problems. β€΅οΈ Check this number, especially in years when your GP has switched CPAs or tax pros as that is done manually in many offices. βοΈ It's also worth pointing out that amending for an address change after the business extension date (September) is hardly worth it. As long as they have the EIN right, just get the address right for next year. Last bit on EINs - if you're investing through a single member LLC / disregarded entity (DE), the ultimate owner information belongs in Boxes E and F with the DE information going in Box H2. This causes some confusion every year with investors thinking they're getting the K1 to the wrong entity when in reality they just don't know how to read it. π The TakeawayFor what it's worth, there's a lot of other ways your K1s are probably wrong π but that's for another time. When you get your K1s this year, take a look at these handful of items to help get the questions rolling before October 14th. β²οΈ π«‘ Meme Cleanser π§Ό
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I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox π Also on YouTube at PlugAccountingandTax!
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