Taxes for small private real estate fund (MMLLC)

[Justin Rowe]

I’m looking for some specific advice on structuring a small (<$250k) private real estate fund. I am starting with a passive group of friends and family investors. The goal is to raise capital from 2-3 parties to invest in a single property and distribute profits over 3-7 years. Within the first 3 years, I’d like to repeat this process, possibly with larger dollar amounts or a larger group of investors. I understand there are ways to get off the ground more efficiently and less expensively but it’s important to me to do this in a way so I learn the details in a scalable way. I want to use a waterfall structure to distribute profits based on a preferred return and structure the entity in a way that allows for a series of independent investments or funds. I’m close enough to retirement age that I could make this my primary occupation within a few years and, with a little luck, invest on my own - but I like the idea of also investing other people’s money as a way to help grow their capital alongside my own.

I’m fairly early on in my research but I am stuck on what seems a straight-forward tax problem. If I am the only Sponsor / General Partner / Manager of the fund (as spelled out in the operating agreement), am I the only one who files a Schedule E at the end of the year - or do all Limited Partners / Members also file one? My understanding is that I can create a Private Real Estate Fund MMLLC naming myself as the Manager / General Partner and each member would just file the K-1 I supply. If that’s true, the operating income/loss of the MMLLC would pass through to only my tax return and the other investors would not experience a taxable event until the MMLLC issues a distribution. Do I have that correct? Any clear gotchas you see as I’ve spelled out my thoughts?

I appreciate any guidance from the community, especially from someone who has done something similar.

Justin