By Randall Weaver, CPA and Dustin Peck, CPA
Real estate syndications have become an increasingly popular structure for pooling investor capital to acquire and manage larger real estate investments. While syndications can unlock growth opportunities for sponsors and syndicators, they also introduce significant financial, legal, and tax complexities. Syndicators must ensure that the structure and accounting for their deals not only comply with regulations but also align with the expectations of investors and long-term business goals.
Most syndications include at least two ownership classes: a “Class A” for passive investors and a “Class B” (or general partner class) for the syndicators who manage the deal. This bifurcation allows syndicators to retain decision-making authority while ensuring investors receive priority in economic returns. Thoughtful structuring is essential, particularly regarding preferred returns, promote structures, and waterfall provisions, to align incentives between syndicators and investors.
Proper allocation of profits, losses, and distributions is one of the most critical elements in real estate syndications. These allocations must align with the syndication’s operating agreement as well as applicable tax regulations (particularly IRC Section 704). Improper or inconsistent allocations can create tax compliance issues and potential disputes. A robust and thoughtful operating agreement is the first step to ensure compliance with regulations as well as allocations that meet investor expectations. Next, the guidelines of the operating agreement must be followed in practice as the syndication makes distributions and reports profits and losses on its tax return. Syndicators should ensure their accounting systems and advisors can track these allocations precisely to maintain transparency and investor confidence.
Capital accounts serve as the backbone of syndication accounting. Each investor’s contributions, allocations of income and losses, and distributions must be carefully tracked. Accurate capital account maintenance ensures correct reporting for IRS compliance and provides clarity to investors regarding their position in the syndicate. Without proper systems in place, syndicators risk costly errors, investor disputes, and complications in future refinancings or exits.
Tax planning in syndications can be highly nuanced. Syndicators should work closely with tax advisors to leverage strategies such as cost segregation studies, bonus depreciation, and 1031 exchanges to maximize investor returns through tax savings. At the same time, there are several potential tax pitfalls for unwary syndicators. Tax concepts such as nonrecourse and recourse debt allocations, passive loss rules, or tax shelter classification can lead to unexpected consequences if not properly considered. Syndicators should consult with qualified tax professionals in advance to prevent or minimize the negative impacts of these tax rules while optimizing any opportunities for tax savings. Strategies for tax savings can originate in unexpected places, such as negotiating the terms of guarantees on loans. In addition to ensuring compliance and improving tax results, developing an advanced understanding of tax impacts can improve investor relations. Clear communication of tax outcomes with investors is critical to maintaining trust and credibility.
A successful syndication is not only about closing the deal but also about building an infrastructure that can scale with future projects. Robust accounting practices, well-drafted operating agreements, and proactive tax planning enable syndicators to focus on growth while staying compliant. By putting the right systems in place early, syndicators can avoid headaches down the road and foster long-term investor relationships.
If you are navigating the complexities of structuring, accounting, or tax planning for your real estate syndication, reach out to Trout CPA for guidance tailored to your needs.
Randall Weaver, CPA
Randall joined Trout CPA in 2011. He graduated from Millersville University with a Bachelor of Science degree in Business Administration (magna cum laude) in 2006. Randall has over 19 years of accounting experience. He currently serves on the firm's Construction and Real Estate, Manufacturing, and Estate & Trust Practice Groups. As a Partner, Randall manages all aspects of tax planning and preparation and business consulting for some of the firm's significant clients. Randall enjoys activities with his family, being involved with his church, and rooting for Philadelphia sports teams. He lives in Lancaster County with his wife and two children.
Dustin Peck, CPA
Dustin joined Trout CPA in 2018 after graduating from Messiah College (summa cum laude) with a Bachelor of Science degree in Accounting with a minor in Economics. Dustin serves on the firm’s Construction & Real Estate and Consumer Services Industry Groups. He also serves on the firm’s Multistate Taxation Industry Group. In his free time, Dustin enjoys spending time with his family and friends and participating in outdoor activities such as hiking, biking, and hunting. He lives in Lancaster County with his wife.