06.18.18

Real Estate Group Newsletter – Spring 2018
Justin L. Sylvan, Kathy Z. Jeziorski

Is a General Partner Fund Right for Your Deal?
Justin Sylvan, CPA

The process to launch a private real estate fund involves navigating a variety of structural complexities and business challenges. As the real estate boom reaches new heights, real estate private equity sponsors are becoming increasingly constrained and looking for new ways to fund their real estate projects. This article discusses why some sponsors turn to general partner (GP) funds to meet their capital contribution obligations while maintaining the freedom to invest in additional projects.

Typical structure

A typical real estate project is structured as a limited liability company (LLC) or limited partnership (LP), with the sponsor serving as the general partner. In addition to managing the daily operations of the project, the sponsor is expected to make a substantial capital contribution and raise capital from other sources. In exchange for doing so much of the heavy lifting, the sponsor receives a disproportionate share of the profits (that is, more than its capital contribution percentage), commonly known as the promote.

Often sponsors participate in multiple projects. Because they do not receive promote distributions until the later stages of a project, some sponsors might not have the necessary capital to participate in all of these projects. That is where a GP fund can come in handy.

To start, the sponsor forms a joint venture equity fund to raise sufficient capital to cover its investment requirements, giving investors the opportunity to participate in the GP project and share in the sponsor’s promote distributions. The fund could raise additional capital through a private offering and then use the proceeds to make the requisite GP investment in several projects.

Of course, the sponsor might run into some resistance. For example, limited partners in the underlying project might worry that the sponsor will lose the incentive to run the project efficiently and minimize risks when it has less of a financial interest at stake in the project. But, the sponsor’s compensation remains closely tied to the project’s performance, and the sponsor risks reputational damage that could hurt its odds of raising funds in the future.

Important provisions

These arrangements are not to be entered into lightly, though. If you are thinking about starting a GP fund, consider the following:

  • Distributions
    These generally follow the customary private equity structure: GP fund investors receive the amount of their original investment, plus a preferred return. The fund will then divide extra profits after the payments between the investors and the sponsor, according to a predetermined formula. That formula may shift the split in the sponsor’s favor as the project achieves certain benchmark internal rates of return. Distribution timing tends to follow that of the underlying project. (This timing applies to capital calls, too.)
  • Fee Income
    Investors in the GP fund usually pay the sponsor a management fee based on the amount of capital the fund invests. The fund generally does not share in the fees the sponsor receives for services to the underlying real estate project (for example, property management or leasing fees).
  • Decision-Making Authority
    GP fund investors rarely participate in the management decisions — understandably, the other investors in the underlying project would frown on that. After all, they invested in the project based in part on the sponsor’s expertise.

Proceed with caution

Done right, GP funds can serve as valuable investment vehicles for both sponsors and investors. However, the arrangements generally are complicated, so consult with your CPA to be sure you are covering all of your bases.

For more information, contact Justin Sylvan at jsylvan@orba.com or 312.670.7444. Visit ORBA.com to learn more about our Real Estate Group.
©2018


Are you in compliance with the new partnership audit rules?
Kathy Jeziorski, CPA

Many real estate-related businesses are formed as partnerships, making them subject to the regulations for partnership audits under the Bipartisan Budget Act of 2015 (BBA).The proposed regulations, which significantly change the previous rules regarding partnership audits and liability for any resulting adjustments , take effect for taxable years beginning after December 31, 2017.

Liability for adjustments

The proposed regulations provide a default audit regime, under which the IRS will assess tax on an adjustment that increases a partnership’s income against the partnership itself, instead of against the individual partners from that tax year. That means the economic burden will be borne by the partners in place when the audit adjustment is completed, not those in place during the tax year that income was underreported.

Alternatively, a partnership can elect to push out the adjusted items to the partners from the relevant tax year. The partners would then take their shares of the adjustments into account on their individual tax returns. Separate proposed regulations provide rules addressing how partners that are pass-through entities (such as partnerships or limited liability companies) take into account pushed-out adjustments.

Partnerships must make the push-out election no later than 45 days after the date of the IRS notice of final partnership adjustment. The partnership must provide a statement to the IRS and every partner from the relevant tax year, reporting each partner’s share of the adjustment.

Certain partnerships with 100 or fewer partners generally can elect to opt out of the BBA rules entirely, so long as each partner is an individual, C corporation, foreign entity treated as a C corporation, S corporation or the estate of a deceased partner. However, if a partner is a partnership or limited liability company, the overall partnership cannot elect out of the rules.

Partnerships must elect out of the rules annually and must disclose certain demographic information about each partner during the taxable year. If the IRS approves the election, it will audit the partnership under the rules that apply to individual taxpayers.

The new partnership representative

The BBA replaces the previous tax matters partner with a partnership representative who has the sole authority to act on the partnership’s behalf in IRS proceedings. Partnership representatives have broad authority to bind their partnerships and partners, including the ability to extend the statute of limitations, proceed to court, enter settlements and make push-out elections.

The partnership representative must have a substantial presence in the United States, but need not be a partner. Moreover, the BBA does not require the representative to communicate with the partners during an audit.

In addition, the partnership must designate a partnership representative every year on its tax return, and the appointment is valid only for that year. If the partnership fails to designate a representative for a taxable year, the IRS has the power to do so.

Far-reaching implications

The effects of the new rules could reach beyond partnerships’ federal income tax liabilities, as the rules also have implications for state and local taxes, financial reporting and the formation of new partnerships. Contact your CPA to ensure your real estate business is in the best position to protect itself under the regulations .

For more information, contact Kathy Jeziorski at kjeziorski@orba.com or 312.670.7444. Visit orba.com to learn more about our Real Estate Group.
©2018

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Firms News

09.12.18

ORBA Welcomes New Hires to Tax, Audit and Human Resources
Ostrow Reisin Berk & Abrams, Ltd. (ORBA), one of Chicago’s largest public accounting firms, is pleased to welcome Joshua Goldschmidt and Joshua Rincy to its Tax Department, Roxana Stupar to its Audit Department, and Andrew J. Butkus, Jr., PHR to its Human Resources Department as an HR Specialist/Recruiter.

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Media Mentions

09.13.18

Various Media – ORBA Welcomes New Hires to Audit, Tax, HR

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