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How Is K1 Income Taxed

How Is K1 Income Taxed: The Multifamily Passive Income Tax Rate Explained

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This article is part of our passive investors guide on real estate syndications, available here.

Investing into private real estate offerings such as a multifamily real estate syndication enables passive investors, who in a partnership are referred to as Limited Partners (LP), access to tremendous passive income tax benefits. These tax benefits are passed down to the passive investor in the form of a document issued by the Internal Revenue Service (IRS), and that form is called the Schedule K-1 (Form 1065).

In this guide, we’ll go in-depth about what a Schedule K-1 is, how you read a K-1, how net rental real estate income or passive income is taxed, and much more.

Key Takeaways

  • The U.S. tax code allows for entities such as Partnerships, S corporations, Trusts, and Estates to issue a K-1 to the owners or partners in an investment.
  • Understanding how a Schedule K-1 functions and how to read it is crucial to the function of being a passive or limited partner in a syndication. This report is your share of the partnership’s income, losses, deductions, and credits.
  • The partnership itself does not pay taxes; each individual in the partnership is responsible for their share.
  • There are four main boxes that every passive investor must understand when reading their K-1 form.
  • Individual investors or LPs should expect to receive their K-1 sometime between mid-March to early April.

What is a Schedule K-1 Form & How Does it Affect Your taxable income?

The U.S. tax code allows for entities such as Partnerships, S corporations, Trusts, and Estates to issue a K-1 to the owners or partners in an investment. The partnership itself does not pay taxes; each individual in the partnership is responsible for their share. The direct ownership that passive investors get from investing in a syndication, for example, is all the pass-through tax advantages and all the investment income and expenses that flow down from the partnership to each owner in the deal. 

The General Partner (GP), also referred to as the syndicator or sponsor of a deal (like us here at Willowdale Equity), would prepare and file a 1065 information tax form. The partnership would then calculate a K-1 tax form that details each limited partner/passive investor’s share of the firm’s income, losses, deductions, credits, and how many distributions were given to them in that year. The passive investor or LP would then file their K-1 with their personal tax return.

For simple math, let’s say we have $1,000,000 in income in the given tax year and only two partners. Each partner would receive a K-1 reflecting their income pro-rata share of the partnership, which in this case would be $500,000 each.

Schedule K-1 Form Sections You Should Know

There are four main boxes that every passive investor must understand when reading their K-1 form.

To get a blank example Schedule K-1 form, you can visit the IRS’s website.

  • Box JPartner’s share of profit, loss, and capital
  • Box 2 – Net rental real estate income (loss)
  • Box 19 – Distributions
  • Box L – Partner’s capital account analysis
Passive Real estate Income Schedule K-1 Example

Box J - Partners share of profit, loss, and capital

Box J shows a breakdown of the LP’s ownership percentage in the deal. A simple example would be if the partnership raised $1,000,000 and this LP invested or contributed $50,000 into the partnership, reflecting a 5% ownership percentage.

Box 2 - Net rental real estate income (loss)

Box 2 reflects the net rental income gain or loss or simply how much money was made or lost for the LP based on their share of ownership. This net number calculates revenues and fewer expenses and includes all the depreciation that can be utilized.

 Sometimes, the depreciation can exceed the net income number, reflecting a “Net rental real estate income (loss)” like in the above example where this LP has a -$12,000 loss, even though they received $3,000 in distributions on the year.

Box 19 - Distributions

Box 19 shows the total amount of distributions we’re paid to the investor in the said year. In the above example, the LP received $3,000 in distributions throughout the year, even though box 2, “Net rental real estate income (loss),” shows a loss of -$12,000.

The loss does not reflect underperformance from the investment or loss of capital; it’s just a “paper loss” that the investor gets from the depreciation, and the net number reflects their share of the “paper loss.” The “paper loss” allows us to keep more from our investments, lowering our passive income taxable amount to as low as $0 in some cases.

[VIDEO MINI-SERIES] K-1’s and how you can start investing your W-2 or earned income to create tax-advantaged passive income.

Box L - Partner's capital account analysis

Box L shows a snippet of the LP’s capital account. The capital account reflects how much they invested into the deal from the start of the investment, how much they contributed during the year, and what they earned during the year from the partnership.

In the above example, under “Beginning capital account,” you can see that this LP invested $50,000 to start the investment. Also, under “Withdrawal & distributions'” you can see that they received $3,000 in distributions during the year. It also shows the “paper loss” of $12,000 under “Current year net income (loss),” which reflects what they made or lost on the year, “on paper.”

When should I receive my K-1?

Filing a partnership return is a significant task that requires many experts to help ensure the accuracy of the information and that the partnership maximizes all of the deductions it can take advantage of. 

This is crucial because each individual investor will receive their K-1 based on the partnership’s fillings, so accuracy is critical. That said, it takes some time to put everything together and adequately file the partnership return.

Individual investors or LPs should expect to receive their K-1 sometime between mid-March to early April. But in some cases, the filing can be very complicated and may require a filing extension which would delay when LPs would receive their K-1. 

Please keep in contact with whomever the GP or sponsor is for the deal you’re invested in to get a good idea of the expected timelines for your K-1.  Here at Willowdale Equity, we strive to get our passive investor partners their K1 by mid to late March.

Is rental income passive income?

The general rule from the IRS is that all rental real estate activity is passive, meaning that passive losses from rentals can only be offset by other passive income or gain. 

K-1 net rental real estate income

The tax benefits of passive investing in multifamily syndication are key advantages, especially when you compare it to investing in a Real Estate Investment Trust (REIT). These excellent passive income tax benefits allow investors to create paper losses through what the IRS calls depreciation. The IRS allows us to write off the normal wear and tear usage of the building but not the land over 27.5 years.

Items like plumbing fixtures, windows, and equipment, to name a few, are considered personal property, and the goal is to find the total value of these items and depreciate it over the same 27.5-year period. There’s another way to accelerate that depreciation and claim more “paper loses” is through a cost segregation study. 

This would require hiring a private engineer to come out and do a cost segregation study on the property to establish the value of the personal property.

For example, let’s say the building produced $100,000 in cash flow, but we can claim -$150,000 of depreciation against our cash flow. That would mean we have a -$50,000 loss for the partnership, but let’s say there were only two partners.

Each partner would get a K-1 reflecting a -$25,000 net rental loss even though they made $50,000 in cash flow each.

How is K-1 income taxed and the passive income tax rate

In contrast to your earned income, the Schedule K-1 that you receive each year reflects your net rental real estate revenue – which is the portion subject to lower taxes after subtracting all depreciation. The income you receive from working your W-2 or business is referred to as earned income and is subject to the highest effective tax rate.

You’ll submit the K-1 with your personal income tax return once you receive it. If your K-1 is positive, you’ll have to pay the marginal tax rate on that revenue; if your K-1 shows a loss, you won’t have to pay any taxes! You will have to pay federal and state income taxes depending on where you reside in the United States.

How is K-1 income taxed for real estate investors: [Example 1]

In the above example, let’s say we received a K-1 showing an income of $10,000, and let’s say where I live, and based on my tax bracket, I would fall into the 37% tax rate. Then 37% of the $10,000 (-$3,700) would go to uncle sam on my personal income tax, and I would keep $6,300 of that $10,000.

How is K-1 income taxed for real estate investors: [Example 2]

In the above example, let’s say we received a K-1 showing a loss of -$12,000; in this scenario, I would not owe anything on my personal income tax, even though I may have received a couple of thousand dollars in distributions that year.

Business income, ordinary income for the tax professional. What you need to do with a Schedule K-1

When getting K-1 forms or discussing ordinary business income, leveraging a professional accountant or a reputable website is best. You may still be required to pay tax on any earnings received in retirement accounts on shares held inside a retirement plan for what is called “unrelated business taxable income,” or UBT.

The UBTI occurs when a person has received any income considered ordinary: wages, salary, and tips; rental income from real estate investments; business income from a partnership or an S-corporation.

For years, certain retirement accounts would not be taxed on these accounts. The earnings not put into retirement plans are considered UBTI, which is directly listed on a Schedule K-1. You are required to report this taxable amount at line 43 of your 1040 tax return and will need to complete Form 990-T. You will be issued a deficiency notice if you do not pay the income and distribution tax.

How does K-1 loss affect my taxes?

Since rental real estate activity is passive, you can only offset your passive income with your passive losses, which means you cant apply your passive loss toward your Active or Earned income to reduce your tax liability. However, this can be done if you qualify for real estate professional status, allowing you to carry over your losses.

Typically it would be harder to qualify for this tax status if you’re not a full-time real estate investor and if you had a full-time job outside of real estate. But there are cases where couples qualify for Real Estate professional status together. 

For Example, There was a case of a doctor making $3M a year in active W2 income who had purchased enough commercial real estate and accelerated the depreciation on these assets. He generated enough depreciation or paper loss on this that he was able to offset his entire $3M income on the year.

The IRS had audited him and lost, as his wife, a stay-at-home mom, qualified as a real estate professional as she managed the properties. Now let’s dive into what the implications are for each type of entity.

The Tax Implications of Different Structures:

Ah, the tax maze can be quite the puzzler, especially when it comes to understanding how different entities play into it. Let’s break it down a bit.


First off, we’ve got Partnerships. Now, with these bad boys, the partnership itself doesn’t pay taxes. Instead, each partner takes their cut of the income, losses, deductions, and credits and reports them on their individual tax returns. It’s like divvying up a pizza- everyone gets their slice.

S Corporations

Next up, we’ve got S corporations. These are a bit like partnerships in that they also pass their income, losses, deductions, and credits through to their shareholders. But here’s the kicker: shareholders in an S corp can be employees too, which means they might need to pay some employment taxes on their share of the profits.

C Corporations

These big players in the business arena are known for their separate legal entity status, which means they file their own tax returns and pay taxes at the corporate level. This is what we call “double taxation” – the corporation pays taxes on its profits, and then its shareholders pay taxes again on any dividends they receive.

But hold on, there’s a silver lining here! C Corporations offer some unique tax advantages, especially when it comes to things like deductible business expenses, fringe benefits for employees, and even potential tax credits for certain activities like research and development.

Plus, C Corporations have more flexibility when it comes to structuring their ownership and raising capital. With the ability to issue multiple classes of stock and attract investors through public offerings, they can fuel their growth and expansion with ease.

Now, while the double taxation aspect might seem like a downside, it’s worth noting that C Corporations can also strategically navigate their tax liabilities through careful planning and smart financial management. By reinvesting profits into the business or taking advantage of tax deductions and credits, they can minimize their overall tax burden and maximize their bottom line.

Trusts and Estates

These guys operate a little differently. See, they can be subject to their own tax rates, depending on how they’re structured. Trusts, for example, might have to pay taxes on any income they earn, while Estates might owe taxes on income earned after the owner’s death.

Limited Liability Company (LLC)

Ah, let’s not forget about the versatile Limited Liability Company (LLC) in our tax talk! Picture it like a chameleon of the business world, able to adapt its tax treatment to suit its owners’ preferences.

In its default state, an LLC is what we call a “disregarded entity” for tax purposes. That means the IRS doesn’t see it as a separate tax-paying entity, so the LLC’s profits and losses flow through to its owners, who report them on their personal tax returns. It’s like having your cake and eating it too – you get the liability protection of a corporation without the double taxation.

But here’s where it gets interesting: an LLC can also choose to be taxed as a corporation if it wants to. Yup, that’s right – it’s got options! By electing to be taxed as either a C corporation or an S corporation, an LLC can enjoy different tax benefits and structures depending on its needs and goals.

Now, why might someone choose this route? Well, for starters, being taxed as a corporation can offer some extra flexibility when it comes to things like managing profits, reinvesting in the business, and even saving on self-employment taxes.

Regardless of what entity structure is ultimately chosen, it’s crucial to make sure tax filings are prepared on behalf of the partnerships in a timely manner. Let’s look at some of the consequences of not filing on time and getting partners their K-1 late.

The Consequences of Filing Extensions

Filing extensions for K-1 forms can indeed delay the distribution of important tax documents to investors. However, the consequences of these delays are primarily related to the timing of tax filings and potential penalties for late submission of personal tax returns.

Here are some potential consequences and ways to mitigate them:

1.) Late Filing Penalties:

If the partnership files for an extension and subsequently delays the issuance of K-1 forms, investors may receive their tax documents later than expected. This delay could result in taxpayers missing the deadline for filing their personal tax returns, leading to potential penalties for late filing.

Mitigation: Investors can mitigate the risk of late filing penalties by proactively communicating with the partnership or syndicator to obtain an estimated timeline for K-1 distribution. Additionally, they can plan ahead by requesting an extension for their personal tax return if necessary.

2.) Interest Accrual:

In addition to late filing penalties, taxpayers may also incur interest charges on any outstanding tax liabilities resulting from delayed K-1 forms. Interest accrues on the amount owed from the original tax filing deadline until the taxes are paid in full.

Mitigation: To mitigate interest charges, investors should promptly file their tax returns once they receive their K-1 forms, even if they need to file for an extension. Paying any taxes owed as soon as possible can help minimize the accumulation of interest.

3.) Incomplete or Inaccurate Information:

Delays in issuing K-1 forms may also increase the risk of errors or omissions in the tax documents received by investors. Inaccurate information could lead to complications or audits during the tax filing process.

Mitigation: Investors should carefully review their K-1 forms for accuracy and completeness once they receive them. If any discrepancies are identified, they should promptly contact the partnership or syndicator to request corrections or clarification.

Overall, while filing extensions for K-1 forms may result in delays and potential consequences for investors, proactive communication, planning, and careful review of tax documents can help mitigate these risks.

Frequently Asked Questions About How Does a K1 Affect My Personal Taxes

If your K-1 shows a profit, you’ll be paying the marginal income tax rate on that profit; if your K-1 shows a deficit, you won’t owe any taxes.

Yes, K-1 distributions are considered income, but it’s important to note that the net gain/income on your K-1 is a net number after subtracting your share of the partnership’s income, losses, deductions, and credits.

Rental real estate is passive; you can only offset your passive income by canceling out your passive losses. However, if you meet the requirements for real estate professional status, you may carry over your passive losses towers your active/earned income.

How Is K1 Income Taxed - Conclusion

Understanding how a Schedule K-1 functions and how to read it is crucial to the function of being a passive or limited partner in a syndication. This report is your share of the partnership’s income, losses, deductions, and credits.

Keep this guide close and refer to it every year at tax time. It all starts with understanding your investment options, maybe investing through a self-directed IRA instead of funding your investment as an individual. The higher your overall portfolio income grows, the more you need to know how to decode your schedule k-1 form. Also, the right real estate market is crucial to your success because even if you overpay or come short on a few projections, the market should provide an element of cushion.

DISCLAIMER: This is for informational purposes only. I am not a tax advisor, nor can I provide tax advice; please consult your CPA.


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