By Jose Carrasco, CPA, and Whit Cocanower, J.D., LL.M., Washington, D.C.
Editor: Greg A. Fairbanks, J.D., LL.M.
Questions arise about the proper tax treatment of costs incurred by taxpayers when forming a new partnership. Even if these expenditures do not give rise to an immediate deduction, careful analysis is necessary to ensure that they are properly reflected in the partners' capital accounts and tax bases in their partnership interests. As discussed below, proper accounting for these costs requires consideration of facts that go beyond merely identifying the party that makes the payment.
Sec. 709 and the associated regulations deny deductions for partnership organizational expenses and syndication costs. Examples of potential syndication costs include brokerage fees, registration fees, and legal and accounting fees incurred in connection with issuing and marketing of interests in a partnership. A partnership may elect to amortize its organizational expenses under Sec. 709(b), but no such election is available for syndication costs, which must be capitalized.
This item briefly discusses the tax basis and partnership capital accounting impacts of partner-incurred syndication costs, that is, syndication costs paid by a partner on the partnership's behalf. The regulations require that syndication costs be capitalized, but they otherwise provide limited guidance about how these costs impact the partners' capital accounts and tax bases in their partnership interests when paid by a partner and not the partnership. Further, the tax accounting impact of syndication costs can vary depending on who ultimately bears the economic burden associated with those costs pursuant to the agreement(s) between the parties.
Whose costs are they?
When a partner pays syndication costs on behalf of a partnership, an initial issue to consider is who is treated as paying those costs for federal income tax purposes. As a general rule, where a partner pays syndication costs on behalf of a partnership, the partnership is nevertheless treated as paying those syndication costs for federal income tax purposes.
For instance, in Rev. Rul. 81-153 the IRS ruled that an investor could not deduct syndication costs that it paid in connection with its acquisition of a partnership interest. In that ruling, a partnership (or its promoter) agreed to make payments to various investment and tax advisers in order to obtain their assistance in selling the partnership's interests to their clients. Rev. Rul. 81-153 discusses two methods through which the advisers could receive payment for their services. In situation 1, the partnership rebated a certain amount of the cash it received from the investor in exchange for a partnership interest to the investor, who paid that amount to the adviser. Because the payment to the adviser represented a syndication cost, the IRS ruled that no deduction was allowed to the partnership under Sec. 709.
In situation 2, the investor paid the adviser's fee directly, and the partnership reduced the amount that the investor was required to pay for its partnership interest by an identical amount. Although it was the investor who actually remitted the cash to the adviser, the IRS ruled the partnership was treated as making the payment for federal income tax purposes. Again, neither the investor nor the partnership was entitled to a deduction for the syndication cost.
In Egolf, 87 T.C. 34 (1986), a partnership agreement required one of the partners to pay for and bear the economic burden of the partnership's syndication costs. The partnership also paid the partner a management fee and claimed a deduction for it. The partner reported the management fee as income but also claimed offsetting deductions for the syndication costs that it incurred on behalf of the partnership. The Tax Court viewed the arrangement as an attempt to circumvent Sec. 709 at the partnership level by transforming the syndication costs into a deductible management fee. The court denied the partnership's deduction for the portion of the management fee that represented a reimbursement to the partner for syndication costs paid on behalf of the partnership (and the amount of management fee income recognized by the partner was reduced by an identical amount).
In Rev. Rul. 89-11 the IRS considered another situation in which a partner paid syndication costs on behalf of a partnership under facts that bore some resemblance to those in Egolf. In that ruling, a corporation, which was the general partner in a partnership, incurred syndication costs in connection with an offering of the partnership's interests. The IRS cited Rev. Rul. 81-153 in concluding that the corporation was treated as making a capital contribution to the partnership in the amount of the syndication costs. The partnership was then treated as paying the syndication costs and was required to record the syndication expenditures as an intangible asset on its balance sheet.
Thus, in many situations in which a partner incurs syndication costs on behalf of a partnership, the partnership will be treated as paying those costs for federal income tax purposes. The partner instead is treated as making a capital contribution to the partnership in an amount equal to the syndication costs it incurred on the partnership's behalf.
Impact on outside basis and capital accounts
What are the consequences to a partnership where it is deemed to make an expenditure for syndication costs that were paid on its behalf by a partner? From the partnership's perspective, it receives cash from its partner as a capital contribution, pays the syndication costs, and capitalizes those costs as an intangible asset on its balance sheet. The next consideration is the effect the deemed capital contribution and partnership-level expenditure have on the partner's basis in its partnership interest and the partnership's Sec. 704(b) capital accounts.
Under Sec. 722, the partner increases its tax basis in its partnership interest by the amount of capital it is deemed to contribute to the partnership by virtue of paying syndication costs on the partnership's behalf. The IRS expressly confirmed this conclusion in Rev. Rul. 81-153. A partnership that maintains capital accounts in accordance with the Sec. 704(b) regulations would also credit the amount of the deemed contribution to the partner's capital account.
In certain circumstances, additional analysis may be needed to accurately identify the partner that is treated as funding syndication costs through a capital contribution. Consider the following example:
Example: LP1 and LP2 each contribute $1,000 to a partnership, PRS, upon its formation, and each receives in exchange an equal limited partnership interest. Each limited partner's initial capital account and outside basis in its PRS interest equals $1,000. GP, a general partner in PRS, incurs $150 of syndication costs on behalf of the partnership. However, immediately after formation, PRS reimburses GP for the syndication costs incurred. PRS's partnership agreement provides that LP1 and LP2 are entitled to a return of their $1,000 capital contributions before GP is entitled to any distributions.
Although GP pays the syndication costs in the example, it does not actually bear the economic burden of those costs due to its rights to reimbursement from PRS. Rather, the reimbursement of the syndication costs incurred by GP depletes PRS's assets by $150. Immediately after the reimbursement payment to GP, LP1 and LP2 would each be entitled to receive only $925 of their initial capital contributions upon PRS's liquidation. Even though GP paid cash to the provider, PRS is treated as paying the syndication costs, and the impact of those expenditures should be reflected in the limited partners' capital accounts. Careful analysis of the partnership agreement or other relevant documents is necessary to correctly identify the partner who bears the economic burden of syndication costs paid by or on behalf of a partnership.
The impact on basis is different from a capital account. As discussed above, a partner's initial tax basis and capital account reflect any deemed capital contributions for syndication costs borne by the partner on behalf of the partnership. Unlike a capital account, though, a partner's basis in its partnership interest is generally not affected when the partnership is treated as the payer of the syndication costs. Although Sec. 705(a)(2)(B) requires a partner to reduce its basis in its partnership interest for its distributive share of nondeductible expenditures, that provision only impacts those costs that are "not properly chargeable to capital account." Because syndication costs must be capitalized, partners are not required to reduce their outside basis by their shares of the partnership's syndication costs.
However, a different result occurs for purposes of Sec. 704(b). Regs. Sec. 1.704-1(b)(2)(iv)(i)(2) treats syndication costs as Sec. 705(a)(2)(B) expenditures for purposes of maintaining the partnership's capital accounts. A partner's Sec. 704(b) capital account is reduced by its share of the partnership's Sec. 705(a)(2)(B) expenditures, including its share of a partnership's syndication costs. Thus, Sec. 704(b) takes into account that the syndication cost, as an expenditure of the partnership in that tax year, ultimately reduces the amount the partners will receive on liquidation. In contrast, a partner that pays syndication costs will recognize less capital gain (or more capital loss, as the case may be) upon its disposition of its partnership interest. In other words, there is a permanent difference between a partner's basis in its partnership interest and its Sec. 704(b) capital account equal to the amount of the syndication cost.
In the example, each limited partner would still have a basis of $1,000 in its partnership interest after taking its share of the $150 of syndication costs into account. However, each limited partner's capital account is reduced to $925.
Properly reflecting costs in basis
Syndication costs are frequently incurred in connection with the formation of partnerships. Where a partnership's partners directly or indirectly pay those costs on the partnership's behalf, careful analysis is required to ensure that those costs are properly reflected in the partners' bases in their partnership interests as well as the partnership's capital accounts. Determining whether the syndication cost is incurred by a partnership versus a partner could affect, for example, a partner's distribution entitlement upon a liquidation of the partnership or of a partnership interest.
Greg Fairbanks, J.D., LL.M., is a tax managing director with Grant Thornton LLP in Washington.
For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or firstname.lastname@example.org.
Contributors are members of or associated with Grant Thornton LLP.
Syndication costs are those incurred to market or sell an interest in the fund. These costs can include printing marketing materials and paying commissions to a broker who identifies investors for the fund, in addition to professional fees incurred in connection with the issuance and marketing of interests in the fund.Can organizational costs be expensed? ›
If you decide to operate your business as a corporation, the corporation can elect to deduct up to $5,000 of its organizational expenditures and amortize the remainder over a period of 180 months. The $5,000 deducted for organizational expenses must be reduced by the amount by which the expenses exceed $50,000.Are syndication costs intangible assets? ›
Rev. Rul. 85-32 holds that syndication costs are chargeable to capital account. The terms "capitalize" and "chargeable to capital account" indicate that the partnership is to record the syndication expenditures as an intangible asset on its balance sheet.Are syndication costs deductible? ›
Sec. 709 and the associated regulations deny deductions for partnership organizational expenses and syndication costs. Examples of potential syndication costs include brokerage fees, registration fees, and legal and accounting fees incurred in connection with issuing and marketing of interests in a partnership.Should start-up costs be capitalized or expensed? ›
It can be a bit subjective in determining what is a start-up cost, but start-up costs should always be expensed as incurred. Typically, start-up costs include any expense that is incurred prior to the business generating revenue.What expenses can a partnership amortize? ›
Examples of organizational costs that can be amortized include: legal and accounting fees for services related to the organization of the partnership, such as negotiation and preparation of the partnership agreement and. filing fees.How do you account for organizational costs? ›
Accounting for Organizational Costs
You record them when you incur them in the expense category called "startup costs". For example, if you've spent $23,000 preparing your new office and $25,000 on market research, you record $48,000 in startup costs. You balance that with a reduction of $48,000 to your cash account.
195(b)(1)(A), a partnership may elect to deduct startup expenses in the year in which the partnership begins an active trade or business, up to the lesser of (1) the amount of startup expenditures with respect to the active trade or business or (2) $5,000, reduced (but not below zero) by the amount by which the startup ...What is the difference between start-up costs and organizational costs? ›
Start-up costs include any amounts paid or incurred in connection with creating an active trade or business or investigating the creation or acquisition of an active trade or business. Organizational costs include the costs of creating a corporation or partnership.Are placement fees syndication costs? ›
Placement fees are treated as a syndication expense and therefore are not tax deductible when paid from the management fee. But paid through the partnership, the percentage of the fee devoted to an agent is no longer treated as income for the general partners, reducing the total taxable income substantially for GPs.
How to take IRS deductions. The IRS allows you to deduct $5,000 in business startup costs and $5,000 in organizational costs, but only if your total startup costs are $50,000 or less. If your startup costs in either area exceed $50,000, the amount of your allowable deduction will be reduced by the overage.Can you deduct start-up costs with no income? ›
You can either deduct or amortize start-up expenses once your business begins rather than filing business taxes with no income. If you were actively engaged in your trade or business but didn't receive income, then you should file and claim your expenses.Are partnership management fees deductible? ›
Unfortunately, the fees paid are deductible only as an itemized deduction and therefore are not completely deductible, because they are subject to the 2% adjusted-gross-income limitation.Does section 195 apply to partnerships? ›
An election to deduct Sec. 195 or Sec. 709 costs is irrevocable and applies to all startup or organizational costs incurred in connection with the trade, business, or partnership.Can you deduct losses from a partnership? ›
If, in a given taxable year, a partner's share of partnership losses exceeds its outside basis, then the losses are allowed to the extent of basis and any excess amount is carried over for use in the next taxable year in which the partner has outside basis available.Which of the following expenses do not qualify as startup costs? ›
Start-up costs do not include deductible interest, taxes, or research and experimental costs.What type of expenses can be capitalized? ›
What Costs Can Be Capitalized? Capitalized costs can include intangible asset expenses can be capitalized, like patents, software creation, and trademarks. In addition, capitalized costs include transportation, labor, sales taxes, and materials.Do start up costs go on the balance sheet? ›
Where do startup costs go on a balance sheet? These costs would normally appear as either capital or retained earnings in the equity section of your balance sheet, depending upon whether you're operating as a small business or a corporation.What expenses can a partnership amortize over a 15 year period? ›
Startup expenses — both ordinary and necessary — are considered capital expenses, which must be amortized over at least a 15-year period, but longer periods can be elected. However, tax and interest expenses are deducted under the normal rules — these deductions are no different in the startup phase.Is capitalization the same as amortization? ›
The terms "capitalization" and "amortization" refer to the same principle when talking about business assets -- spreading the cost of the assets over a number of years, as opposed to accounting for their full cost at once. Capitalization is a broader term, while amortization is a special case.
The same IRS rules apply to organizational expenses between $50,000 and $55,000, as well as over $55,000. If you do not expect to make a profit in the first year you are in business, you should consider amortizing the full amount of start-up and organizational costs over 15 years.Are organizational costs expensed or capitalized? ›
Unless there are large amounts of organizational expenses, they are usually expensed for GAAP and financial reporting purposes.Are organizational costs an asset or expense? ›
Organization costs can include legal payments, state and federal registration and incorporation fees, promotions, and charges associated with the underwriting of stocks and bonds. Organization costs can be classified as assets on the company's balance sheet.What is not included in organizational costs? ›
Costs not considered to be organizational costs include research and experimental costs, and the costs associated with issuing or selling stock. Organizational costs are incurred whenever a subsidiary is created, so these costs can be incurred repeatedly over the life of a parent company.How do you report start-up costs? ›
To amortize your start-up and organizational expenses in this way, you'll have to fill out and attach Form 4562, Depreciation and Amortization, to your tax return for the first tax year you are in business.Can you deduct expenses before a business starts? ›
Expenses that were startup expenses before your business began become currently deductible business operating expenses. For example, supplies you purchase after your business starts are currently deductible operating expenses. But, supplies you buy before your business begins are startup expenses.Are start-up costs intangible assets? ›
Business startup costs are intangible assets (no physical form), so they must be amortized (spread out over 15 years, for example), beginning with the year your business begins.How do you elect to deduct organizational costs? ›
In the taxable year in which a corporation begins business, an electing corporation may deduct an amount equal to the lesser of the amount of the organizational expenditures of the corporation, or $5,000 (reduced (but not below zero) by the amount by which the organizational expenditures exceed $50,000).How do I deduct business start up costs from personal income? ›
You can deduct up to $5,000 of business start-up costs and up to $5,000 of organizational costs, but those deductions are reduced by the amount that costs exceed $50,000. Any remaining costs must be amortized over 180 months on a straight-line basis beginning with the month in which you begin operating your business.Is equipment a startup cost? ›
A startup cost is any expense incurred when starting a new business. Startup costs will include equipment, incorporation fees, insurance, taxes, and payroll. Although startup costs will vary by your business type and industry — an expense for one company may not apply to another.
The new standard requires the incremental costs related to obtaining a contract (for example, sales commissions and placement fees) to be capitalized as an asset if the costs are expected to be recovered.
In most cases, syndicators will charge a 1 to 3% percent asset management fee based on the gross revenue collected from the property and would be paid out either monthly or annually. In some cases, the asset management fee could be charged per apartment unit.Are placement fees deductible? ›
Yes, placement fees are considered investment expenses.Is rent a startup cost? ›
Rent and payroll expenses before launch are considered startup expenses. The same expenses after launch are considered operating or ongoing expenses.What can be deducted as a business expense? ›
- Car expenses and mileage.
- Office expenses, including rent, utilities, etc.
- Office supplies, including computers, software, etc.
- Health insurance premiums.
- Business phone bills.
- Continuing education courses.
- Parking for business-related trips.
Start-up costs can be defined fairly simply as the expenses that are incurred during the process of setting up a company.What if my business expenses exceed my income? ›
If your business expense deductions for a year are more than your income for that you, you may have a net operating loss (NOL). The way you determine and deal with an NOL depends on your business type. You take a net operating loss on your personal tax return if you are: A sole proprietor.Do I need receipts for all business expenses? ›
What is a business tax receipt? If you plan to include business expenses as deductions on your tax return, the IRS requires you to keep supporting documentation that shows what you bought, how much you paid, and when you bought it.Can you deduct expenses on Schedule C with no income? ›
Even if your business has no income during the tax year, it may still benefit you to file a Schedule C if you have any expenses that qualify for deductions or credits. If you have no income or qualifying expenses for the entire tax year, there is no need to file a Schedule C for your inactive business.How do I deduct investment management fees? ›
Advisory and other investment fees charged on registered assets, regardless of the investments held, aren't tax deductible. Such fees can be paid out of the registered account itself or from a taxable account the investor holds.
While financial advisor fees are not tax deductible now, that doesn't mean they won't be again at some point in the future. Paying attention to changes in the tax code can help you look for opportunities to minimize the amount of taxes you pay on your investments.Are k1 management fees deductible? ›
Are these deductable? No. Because of the Tax Cuts and Jobs Acts (TCJA), you can no longer deduct miscellaneous itemized deductions such as "investment expense" on Schedule A for tax years 2018-2025.What is Section 195 start-up costs examples? ›
Common examples of Section 195 start-up expenses include employee training, rent, utilities, and marketing expenses incurred prior to opening a business. In the tax year when active conduct of business commences, the Section 195 rules allow taxpayers to elect to amortize start-up expenses.Can organizational costs be expensed? ›
If you decide to operate your business as a corporation, the corporation can elect to deduct up to $5,000 of its organizational expenditures and amortize the remainder over a period of 180 months. The $5,000 deducted for organizational expenses must be reduced by the amount by which the expenses exceed $50,000.What are section 162 expenses? ›
Section 162(a) allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Section 262, however, provides that no deduction is allowed for personal, living, or family expenses.Are partnership losses ordinary or capital? ›
Generally, a loss allowed under IRC Sec. 165(a) is an ordinary loss because a capital loss results from the sale or exchange of a capital asset. Therefore, even in the case of capital assets, the loss may still be characterized as ordinary because abandonment or worthlessness is not a sale or exchange.How are losses allocated in a partnership? ›
When you form a partnership, you will also create a partnership agreement (an operating agreement for an LLC). In a partnership, profits and losses typically get distributed to owners of the business based on their percentage interests in the partnership.Can partnership losses offset personal income? ›
If you're a sole trader or in a partnership, you may be able to claim business losses by offsetting them against your other personal income (such as investment income) in the same income year.How do real estate syndications work? ›
This strategy invests in a physical real estate asset. Investors are locked in for the agreed term, and the sponsor decides on when to sell or refinance the property. It offers access to large, lucrative investment opportunities with property management services.Are organizational costs expensed or capitalized? ›
Unless there are large amounts of organizational expenses, they are usually expensed for GAAP and financial reporting purposes.
Why is organization expense not a good title for the account that records the costs of organizing a corporation? ›
The reason why such costs are excluded from being organizational costs is that these expenses are generally added to the basis of the assets themselves. Additionally, fees for issuing debt are also not treated as an organizational cost.What is a syndication partnership? ›
Syndication Partner means a third party with whom Company or its Affiliate has contracted to provide Paid Search Services.What fees can I charge for my real estate syndication business? ›
In most cases, syndicators will charge a 1 to 3% percent asset management fee based on the gross revenue collected from the property and would be paid out either monthly or annually. In some cases, the asset management fee could be charged per apartment unit.What is the accounting treatment for organizational costs? ›
Accounting for organizational costs under GAAP is simple. You record them when you incur them in the expense category called "startup costs". For example, if you've spent $23,000 preparing your new office and $25,000 on market research, you record $48,000 in startup costs.Should organizational costs be amortized? ›
If you do not expect to make a profit in the first year you are in business, you should consider amortizing the full amount of start-up and organizational costs over 15 years. This will allow you to minimize taxes in years where you make more money.Do you need to amortize organizational costs? ›
Organizational costs usually only pertain to a corporation or partnership. You can elect to deduct up to $5,000 of business start-up paid or incurred after October 22, 2004. The $5,000 deduction is reduced by the amount your total start-up costs exceed $50,000. Any remaining costs must be amortized.What is not included in organizational costs? ›
Costs not considered to be organizational costs include research and experimental costs, and the costs associated with issuing or selling stock. Organizational costs are incurred whenever a subsidiary is created, so these costs can be incurred repeatedly over the life of a parent company.Can you deduct start-up costs with no income? ›
You can either deduct or amortize start-up expenses once your business begins rather than filing business taxes with no income. If you were actively engaged in your trade or business but didn't receive income, then you should file and claim your expenses.How much start-up costs can be expensed? ›
How to take IRS deductions. The IRS allows you to deduct $5,000 in business startup costs and $5,000 in organizational costs, but only if your total startup costs are $50,000 or less. If your startup costs in either area exceed $50,000, the amount of your allowable deduction will be reduced by the overage.