Why K-1 Tax Forms Can Be Delayed and What Made the 2018 K-1s Challenging
The Tax Cuts and Jobs Act (TCJA) of 2017 introduced a number of changes that impact real estate operators and add some complexity to filing partnership tax returns (Form 1065) and K-1s.
In this article, we will briefly review what a K-1 is, common challenges preventing timely filing, how the TCJA added to these complexities for the 2018 tax year, and how RealtyMogul’s process may benefit investors.
Pass-through entities such as partnerships don’t pay tax at the partnership level. Instead, the partnership files a tax return, Form 10651, and each partner’s share of income, deductions, and credits is “passed through” to the individual via Form K-1.
The individual reports Form K-1 and pays taxes on the share of income on his/her individual tax return, Form 10402.
The deadline for partnerships to file Form 1065 is March 15th¹, and the deadline for individuals to file Form 1040 is April 15th². In theory, you should receive your K-1 by March 15th, in time to file Form 1040 by April 15th; however, in reality, there are several challenges that may inhibit this process.
One of the first challenges to filing Form 1065 on time comes from the sponsorship side. In some cases, day-to-day accounting is handled by third-party property management. At year-end, the sponsor receives the property-level financials from the property manager, which typically are distributed to the sponsor 20 days after year-end. The sponsor will then review the financials, and may need to make adjustments, which, in turn, could delay this step in the process by several weeks.
After the sponsor receives the financials and clears up any issues with the property manager, they send this information to their CPA to file Form 1065. The sooner the CPA receives the information from the sponsor, the sooner the tax preparation process can start.
However, CPAs may take on more tax returns than they can file on-time, which can cause the return to be extended and filed after the March 15th deadline. When that happens, even when the sponsor gets everything in to the CPA on time, Form 1065 and K-1s can be delayed.
For tax year 2018, in particular, the TCJA introduced many changes that cause complexity and uncertainty for taxpayers. Two of these changes are the introduction of the Business Interest Limits (Section 163j³) and the 20% “pass-through” deduction (Section 199A⁴).
In a nutshell, business interest limitations limit the amount of interest a “tax shelter,'' which is any partnership that allocates more than 35% of its losses to limited partners, can deduct.
If a partnership is subject to these limits, the amount of interest it can deduct is limited to the sum of:
Real estate businesses, however, can elect out of these limits, but, in return, have to extend the depreciation period for the underlying property from 27.5 years to 30 years for residential properties and from 39 years to 40 years for commercial properties.
Due to the language included in Section 163j, it was unclear if electing out of these limits would prevent the use of 100% bonus depreciation on property with a class life of less than 20 years that is separated from 27.5 property through a cost segregation study.
While some CPAs interpreted the language to mean that 100% bonus depreciation can still be used after electing out of the business interest limits, it is not at all surprising to see this issue causing confusion and ultimately delaying tax filing for some CPAs and their syndication clients.
The other change from the TCJA that may have caused some confusion with CPAs in 2018 was Section 199A, also known as the 20% pass-through (QBI) deduction. Before the IRS released the safe harbor for landlords, it was unclear as to whether or not rental real estate would qualify for this deduction. Given the overall complexity of this section, it is not surprising that it is also causing delays in the tax filing process.
Rather than having each sponsor send each investor that invests through RealtyMogul’s platform the K-1 directly, which can cause administrative issues itself, RealtyMogul collects the K-1s from the sponsors and has its own CPA firm file and distribute K-1s to investors.
This may be beneficial, because, this year particularly, RealtyMogul’s CPA firm caught many errors in the various K-1s received from sponsors, mostly caused by the two TCJA changes mentioned above. RealtyMogul’s CPA firm was able to help reconcile these errors to ensure investors ultimately received a properly prepared K-1.
As for late K-1 filing, this is a very common issue in the world of private real estate investing. RealtyMogul asset management team understands this and works closely with sponsors to mitigate this as much as possible.
Three months prior to the March 15th deadline, RealtyMogul reminds each sponsor on its platform about its K-1 submission expectations. In early February, RealtyMogul again reminds sponsors of its February 28th internal deadline. RealtyMogul works jointly with any sponsor who is lagging behind that internal deadline to help ensure the majority of K-1s get finalized by March 15th.
Late K-1s are unfortunately a common problem in the world of private real estate investing due to discrepancies with property managers at the sponsor level, and their CPAs taking on more tax returns that they can file on time.
Coupled with the new changes from the TCJA, it is not surprising to see late K-1s for the 2018 tax year.
Now that the Federal government has cleared up the TCJA tax-reporting confusion, CPAs have learned from the 2018 tax year filing, and with internal changes RealtyMogul is making with some Sponsors to improve their reporting process, RealtyMogul believes that the 2019 tax year filing may be much smoother.
About the author: Thomas Castelli, CPA is a Tax Strategist and real estate investor that helps other real estate investors keep more of their hard-earned dollars in their pockets and out of the government’s.
Please note: The information included in this article only pertains to our private placement opportunities only open to our accredited investors. Information contained herein has been secured from sources RealtyMogul believes are reliable but should not be considered tax advice. We make no representations or warranties as to the accuracy of such information and accept no liability. We suggest that you consult with a tax advisor, CPA, financial advisor, attorney, accountant, and any other professional that can help you to understand and assess the risks and tax implications associated with any investment.
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