I am looking to invest in real estate as a partner. The property management company will issue a K-1 for tax purposes. Can you help me understand the forms and tax treatment of income and passive losses? For example:
Invested: $50,000 in equity investment
Year 1: $2,000 distribution; $5,000 passive activity loss
Year 2: $2,000 distribution; $5,000 passive activity loss
Year 3: Sale. $60,000 distribution.
In year 1 and year 2, can I offset the $2,000 distribution against $5,000 in passive activity loss for tax purposes? In year 3, can I offset the income from asset sale against the passive activity loss from years 1 and 2?
With the property management company issuing you a Form K-1, it will be responsible for the preparation of the partnership’s tax returns and all the calculations that go with it. Calculating the gain or loss on the sale of a property, figuring out the net taxable income, and reporting all the income and expenses will be reflected on your K-1 for your percentage of ownership. This will keep the preparation of your personal tax returns straightforward, as you will have everything you need on your K-1.
With that said, let’s address your questions on how these activities affect your taxes. With regard to distributions, they typically have no impact on your tax return and do not offset any gains or income. Distributions represent a removal of your partner capital. Passive activity losses may be used to offset other income on your personal tax return, depending on how much overall income you are showing on your return and your filing status. Any losses that cannot be taken become suspended losses, and they carry forward indefinitely until they can either be used or the property is disposed of. To answer your specific questions, distributions do not offset losses, but prior-year losses would offset a current year gain, if they have not already been realized.
Real estate investing can have a significant impact on your tax situation and can complicate your return. With the recent changes in the tax laws, it would benefit you to sit down and review your situation with a professional who handles these scenarios. They can look at your fact pattern and give you more direct advice on the impact to your return. The PICPA website has a handy CPA locator to help you find a professional in your area.
For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.
Answered by: Eric S. MacCollum, CPA, is a principal with Hudak and Company in Lemoyne, Pa.