K1 challenges on syndication

[Roy Mitle]

I invested 50K in a syndicate. They used cost seggregation and put 50K as losses in year 1.  This showed up in box2 of K1. My CPA put that as loss in my tax return and carried it over.

Next year they sold the property for a gain of 32K. They put that 32K in box 10. I also see 5K as rental income loss in box 2 of the K1.

My CPA says that 32K is section 1231 gain and so goes into capital gains

However, I feel the box 10 gain should go against my loss of 50K +5K from box2. So I should not be paying any extra taxes. The syndicate agrees with my position. 

In a nutshell, can I offset my gain in box10 with loss from box2 and other passive activity losses (eg. I have a rental property that has passive carryover loss ~125K from years of depreciation)

[Michael Plaks]

@Roy Mitle

Your post may be omitting important details, so my answer is based on what you shared. For instance, I assume that the sale of the property was also the final year of the syndication and you received a "final" K1.

1. Yes, you're correct, the carryforward loss of $50k from the last year should offset your gain. It does not directly offset it, the mechanics are complex, but you should benefit from the $50k losses, resulting in no additional taxes from the sale. I'd speculate that your CPA failed to check the "complete disposition of activity" checkbox in his tax software, keeping these losses locked instead of releasing them.

2. Regardless of the K1 being final, any time you have 1231 gains on K1, they are "gains from passive activity" and they can be offset by losses from any other passive activity, i.e. your $125k stash.

3. Doing cost segregation in year 1 and selling the same property in year 2 makes me question the competence if your syndicator. Normally, it's a counterproductive move with such short cycle.

[Michael Plaks]

@Roy Mitle

Your post may be omitting important details, so my answer is based on what you shared. For instance, I assume that the sale of the property was also the final year of the syndication and you received a "final" K1.

1. Yes, you're correct, the carryforward loss of $50k from the last year should offset your gain. It does not directly offset it, the mechanics are complex, but you should benefit from the $50k losses, resulting in no additional taxes from the sale. I'd speculate that your CPA failed to check the "complete disposition of activity" checkbox in his tax software, keeping these losses locked instead of releasing them.

2. Regardless of the K1 being final, any time you have 1231 gains on K1, they are "gains from passive activity" and they can be offset by losses from any other passive activity, i.e. your $125k stash.

3. Doing cost segregation in year 1 and selling the same property in year 2 makes me question the competence if your syndicator. Normally, it's a counterproductive move with such short cycle.

[Basit Siddiqi]

I am sorry, but I would run from that syndicator

It sounds like you lost $13,000 from this investment or at least this property calculated as follows
($50,000) + $5,000 + $32,000 = $13,000

On top of that, he may have increased your overall tax burden by doing a cost segregation in year 1...

[Bruce D. Kowal]

Consult a CPA who knows what he is doing and file this:  Notice of Inconsistent Treatment I have done this several times for investors who got screwed by the GP.  It works.  Send a paper copy of the return, not efile.  And mail the return on last day of extended due date.  Attach this form as the LAST page of the paper return.

[Roy Mitle]

@Michael Plaks

I misspoke, it doesn't say final K1. The sale is investment sale. We had one part sold last year and another this year. So I'll probably get "final K1" next year.

#2. Is this true. So the syndicate did a partial sale - investment sale. This can offset my passive activity loss. I didn't find anything in the IRS instructions. Would love to get more clarification. Thanks!

[Roy Mitle]

Ok so this year I got my final K1 and I think I know how this work (my bad in that I thought last year was final K1)

To confirm in final K1, all the passive losses can now be taken and they come to schE as allowed passive losses. Before final K1 they just get carry forward.

Since they are now allowed, they go to sch1 line5 (from schE line 41) and now they can offset active income (I get pension so line t on schedule 1)

Would love to get confirmation @Michael Plaks

If this is true a sound strategy is to get bonus depreciation to get as much loss as possible (which gets to reduce my pension income) and as much sec1231 gain (which becomes cap gain)

[Michael Plaks]

@Roy Mitle

Yes, the old losses will travel through Sch 1, line 5, as you described. There also will be Section 1231 gains from the final K-1 that end up on line 7 of 1040. And your pension is not on Sch 1, it's directly on line 5 of your 1040.

Whether or not your old losses offset your pension or your gains is a very complex question, but the bottom line is: yes, the losses become deductible.

Now, you astutely suggested that you may "win" the game by increasing up front depreciation, even though it is offset by a correspondingly higher gain. You think that the former offsets your pension. Not really. The increased depreciation will offset not the capital gains but depreciation recapture portion of it, which is taxed at the same rate as your pension. It's reported as "unrecaptured section 1250 gain" on your K-1. And the real mechanics underneath are very complex, but no, you do not win this game. Also, you do not control it inside a syndication, it's decided by your syndicator.

And there're several other complications we're not discussing here.

[Roy Mitle]

Quote from @Michael Plaks:

@Roy Mitle

Yes, the old losses will travel through Sch 1, line 5, as you described. There also will be Section 1231 gains from the final K-1 that end up on line 7 of 1040. And your pension is not on Sch 1, it's directly on line 5 of your 1040.

Whether or not your old losses offset your pension or your gains is a very complex question, but the bottom line is: yes, the losses become deductible.

Now, you astutely suggested that you may "win" the game by increasing up front depreciation, even though it is offset by a correspondingly higher gain. You think that the former offsets your pension. Not really. The increased depreciation will offset not the capital gains but depreciation recapture portion of it, which is taxed at the same rate as your pension. It's reported as "unrecaptured section 1250 gain" on your K-1. And the real mechanics underneath are very complex, but no, you do not win this game. Also, you do not control it inside a syndication, it's decided by your syndicator.

And there're several other complications we're not discussing here.

 Ok. I get the depreciation aspects. 

However since the accumulated passive losses ultimately do end up on 1040 as losses they do get converted to active losses. They do end up lowering your income. So that’s great 

[Tushar P.]

Quote from @Roy Mitle:

To confirm in final K1, all the passive losses can now be taken and they come to schE as allowed passive losses. Before final K1 they just get carry forward.

Since they are now allowed, they go to sch1 line5 (from schE line 41) and now they can offset active income@Michael Plaks

I understand that the suspended losses get released and become “allowed” when the K-1 is marked final. But how do the suspended losses for final K-1 flow into Schedule E line 41 (or line 32): from line 28 column g (passive loss allowed via 8582) or from line 28 column i (non passive loss allowed)?

Does it even matter? Does it depend on whether the CPA selected only “final K-1” or selected both “final K-1” AND “complete disposition” in their software. Wondering which one would be correct or if both are correct…

@Roy Mitle @Michael Plaks 

[Stuart Udis]

Often overlooked but understanding the tax strategies the syndicator plans to use should be part of the vetting process. I’m also very interested in knowing who is selected to be the tax advisor/accounting firm. 

[Michael Plaks]

I suggest to focus on the result and not on the mechanics of forms and software. In the final year of a partnership, the result should be:
1. All losses and gains - of any flavor - from the current year are applied
2. All previously suspended passive losses are applied
3. Gain or loss on disposition of the partnership interest itself (don't ask, a very complex topic)

[Ashish Acharya]

@Roy Mitle When the syndicate sold the property, the $32K gain (Box 10) is a Section 1231 gain, typically treated as capital gain. However, since the property was fully disposed of, your passive losses from Box 2 ($50K + $5K) and other passive losses (e.g., $125K from your rental) can be used to offset this gain. Your CPA should apply these passive losses now that the activity has been fully disposed of, ensuring the gain is correctly offset.


This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.