Reporting investments for tax purposes is typically a task best left for CPAs. For example, most people find it challenging to identify line items like net rental real estate income and an investment portfolio's gains.
To make things easier, we've broken down one tax form that every syndicator should know, Schedule K-1's. This form is required to report investments and income on items such as investment property.
A Schedule K-1 is a federal tax document provided by the IRS and issued by entities such as Partnerships, S corporations, and Trusts and Estates to report earnings, losses, and dividends. Under the United States Internal revenue code, these institutions can utilize the "pass-through" taxation method to shift income liability from the entity to individuals that benefited from any profits gained on the investment.
Commercial real estate investments as part of a group or syndication also require that you file a Schedule K-1. The IRS bases this requirement on the equity contribution or agreements between the investor and the general partner (GP). In addition, the entity must show net operating profits or losses in its business.
When two or more people form a partnership to conduct business for a profit, the owners must distribute all earnings to their partners. The partners are then responsible for paying taxes on the income.
Partnerships are considered "pass-through" entities, meaning the business itself does not pay taxes; the partners do. In this case, each partner receives a K-1 statement that reports their earnings, deductions, and credits.
For example: if a business generates $600,000 in taxable income under a partnership agreement involving six equal partners, each partner will receive a K-1 indicating the earnings of $100,000 (or 1/6 of the total taxable income) to report to the IRS. This tax condition is also proper for investments in limited partnerships and some ETFs.
Identical to Partnerships, S Corporations file K-1's and accompany them with the Form 1120-S every year. The owners of the S-Corp are then responsible for distributing K-1's to their stockholders, who pay taxes as partners of the business. The stockholders are then required to report their income, credits, and deductions to the IRS. Note: this applies to companies with fewer than 100 stockholders.
Trusts and Estates are entirely different from Partnerships and S Corporations in filing taxes. In some cases, a trust will pay income tax instead of shifting the responsibility to the beneficiaries.
There are some instances where a trust or estate may record pass-through income on the tax returns of their beneficiaries. In this case, the beneficiary receives a Schedule K-1, exhibiting any taxable gain.
Investors who are also equity holders in an entity can expect to receive a pro-rata share of the entity's profits and losses. For example, if an LLC submits a tax return, all deductions and income will be claimed by the entity. In this case, a form K-1 will be issued to the investor by the company. Preparation of the investor's tax return would reference that K-1.
Distributions listed on Form K-1's are generally not taxable, but any amount distributed, on the other hand, could reduce an investor's basis and be treated as a return of capital.
Whether you're an experienced or inexperienced investor. To fully comprehend how rental real estate investments affect your tax situation, you should always speak with a CPA.
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