Partnership Tax: Section 754 Elections, Refinance Distributions, and More

In this episode of the Major League Real Estate Podcast, hosts Nathan Sosa and Matt Hamilton take on listener-submitted questions in their first Partnership Tax Mailbag. Fresh off paternity leave, Matt shares a few lighthearted parenting stories before diving deep into the technical side of real estate syndication tax planning. Together, they break down Section 754 elections, refinance distributions, retirement account investors, partnership audit rules, disguised sales, and more.

Welcoming Matt Back from Paternity Leave

Nathan opens by welcoming Matt Hamilton back to the show after a month of fatherhood. Matt shares what it’s been like adjusting to life with a newborn, from sleepless nights to rapid diaper changes, before shifting gears into tax talk.

Mailbag Format & Listener Questions

For this episode, Nathan and Matt answer questions submitted by listeners and clients. Each topic touches on real-world issues faced by syndicators and investors in real estate partnerships.

Section 754 Elections: When and Why They Matter

Matt explains what a Section 754 election is and why it’s important when new partners buy into a partnership or when buyouts occur.

• It allows incoming investors to step up their basis and claim depreciation aligned with fair market value.
• Many private equity firms require it before committing capital.
• Once made, the election applies permanently, impacting both step-ups and potential step-downs.

Nathan adds that operating agreements should authorize the manager to make the election and stresses the importance of weighing the long-term compliance costs before locking in.

Refinance Returns and Investor Tax Liability

The next question covers whether refinance proceeds returned to investors are taxable.

• Generally, distributions are a return of capital and reduce basis without immediate tax.
• If distributions exceed basis, partners may face additional income or capital gain.
• Syndicators should consult CPAs before refinancing to avoid unexpected investor tax consequences.

Retirement Accounts in Partnerships

What happens when some investors contribute through IRAs or 401(k)s?

• From an operating perspective, they’re treated like any other LP.
• The key issue is ensuring K-1s disclose Unrelated Business Taxable Income (UBTI) so investors can stay compliant.
• Missing this disclosure can create problems for both investors and their CPAs.

Partnership Audit Rules & IRS Changes

Nathan and Matt explain the centralized partnership audit regime:

• Previously, audits required amended returns and reissued K-1s for prior years.
• Now, adjustments are generally pushed into the current year via an Administrative Adjustment Request (AAR).
• While easier for the IRS and less burdensome for investors, it creates extra work for preparers and removes the option to amend prior filings in many cases.
• Electing out isn’t available if non-individual entities are partners, which limits flexibility for larger syndications.

Allocating Losses to Certain Investors

Can syndicators choose to allocate more losses to specific investors?

• Technically, allocations can be written into the operating agreement.
• However, the IRS requires substantial economic effect—the allocations must reflect actual economic risk.
• Creative allocation strategies without true economic substance can be challenged in audit.

Disguised Sales in Partnerships

The episode closes with a discussion of disguised sales.

• If a partner contributes property and quickly receives a cash distribution, the IRS may treat it as a taxable sale rather than a contribution.
• The IRS looks at intent and overall transaction structure.
• Syndicators should avoid setups that “walk and quack” like sales, even if structured through partnerships.

Nathan references the Chicago Cubs case, where ownership was challenged under disguised sale rules, underscoring how easily these issues can surface.

Key Takeaways

• Always review your operating agreement to ensure managers have authority for tax elections.
• Refinance distributions aren’t taxable until they exceed basis—but they can trigger capital gains if not monitored.
• IRA investors require UBTI disclosures on K-1s for compliance.
• Partnership audits are evolving, and large syndications have fewer ways to elect out.
• Allocations must match true economics to survive IRS scrutiny.
• Disguised sales are a common trap. Intent matters as much as structure.

Closing Thoughts

Nathan and Matt wrap up by encouraging listeners to send more questions for future mailbag episodes. Real estate syndication is filled with nuanced tax rules, and understanding them helps both operators and investors avoid costly mistakes.

Want to submit a question or connect with Nathan and Matt?

• Email Nathan at nathan.sosa@hallcpallc.com
• Email Matt at matt.hamilton@hallcpallc.com
• Or check the show notes for a link to schedule a call.

Book a free discovery call with our team.

Disclaimer: This podcast summary was generated from the transcript and may contain some errors or miss key points from the audio recording. Any mention of third-party vendors, products, or services does not constitute an endorsement or recommendation. You should conduct your own due diligence before engaging with any vendor.