Detail

Treasury’s New Partnership Audit Rules Avoid Entity-Level Tax on Real Estate Tiered Partnerships

  • January 5, 2018

New partnership audit rules will allow real estate investors to continue using tiered partnership structures without the risk of a new entity-level tax on the partnership. 

Proposed Treasury regulations published on Dec. 19 end the two-year uncertainty over whether new partnership audit rules would create a significant tax liability for investors in real estate partnerships.  [  link to regulations  ]

Proposed Treasury regulations published on Dec. 19 end the two-year uncertainty over whether new partnership audit rules would create a significant tax liability for investors in real estate partnerships.  At issue was the question of whether the IRS could require partnerships to pay taxes that are appropriately owed by its individual partners.  The tax code has long recognized that partnerships are "pass-through" entities, and that partners in partnerships are only subject to tax on their share of the partnership's income.  But under the new partnership audit reform law, some argued that the IRS could impose an entity-level tax burden in certain cases. 

The Treasury regulations clarify that tiered partnerships will be permitted to use the "push-out" method, in which a partnership is relieved of the entity-level tax after an audit as long as it timely transmits revised K-1 tax statements to its partners, including other partnerships.  [link to regulations] [IRS Guidance on Partnership Audit Regime Eases Some ConcernsAccounting Today (Dec. 26, 2017)] 

Real Estate Roundtable Tax Policy Advisory Committee (TPAC) Member Donald Susswein testified specifically on this issue on behalf of The Roundtable at a September IRS hearing.  At the hearing, Susswein stated that, "the most urgent thing is that prospective investors know that they're only going to be subject to tax on their own tax liability, correctly determined."  He further testified that, "In order to ensure that this new law does not create a hindrance on the economy, it is very important to reassure investors that there is going to be a push-out method for tiered partnerships.  And that can be done now, in 2017, even if other aspects of the regulations are reserved."  [Roundtable Weekly, Sept. 22, 2017)  

Real Estate Roundtable Tax Policy Advisory Committee (TPAC) Member Donald Susswein, left, testified on behalf of The Roundtable about the new partnership audit rules at a Sept. 2017 IRS hearing.

Congress enacted new rules for auditing partnerships and collecting partnership tax adjustments in the Bipartisan Budget Act of 2015  (BBA).  An early version of the legislation would have shifted partnership tax liability to the entity level and imposed joint and several liability on individual partners and the partnership for the full amount owed.  

The Roundtable successfully argued, at the time, that entity level taxation of partnerships would disrupt capital formation and discourage business activity, ultimately hurting job creation and economic growth.  The Roundtable was heavily involved in developing the final BBA approach, which allows partnerships to "push out" tax adjustments through partnerships to the appropriate partner.  The legislation was silent, however, on how the rules would apply to tiered partnerships.  

Although enacted in late 2015, the new partnership audit rules will only take effect for audits of 2018 and later years.  The audits themselves are unlikely to start until 2019 or 2020.  Clarity on the application of the new rules for tiered partnerships is important, however, because of the impact on real estate investor decisions and partnership formations.