Real estate tax

Partnership taxation

The deep end of real estate tax, where the largest dollar swings and the worst malpractice both live, and where a generalist CPA is most likely to get it wrong.

This is the part of the tax code that separates the operators who keep their money from the ones who find out too late. Partnership taxation is not intuitive, it is not what a general-practice CPA does every day, and it is where the largest dollar swings in a real estate deal are decided, often years before anyone notices.

The pages here are the machinery. How a partnership actually allocates income and loss, and why the operating agreement’s allocation language has to satisfy a specific IRS test or get thrown out. What a capital account really tracks and why it is the number that governs who gets what on liquidation. The 754 election, which steps up basis for an incoming partner and is the single most commonly missed move when someone buys into an existing deal. The 704(c) rules that follow a contributed property’s built-in gain around for its entire life. And the gap between tax basis and book basis that quietly determines whether a distribution is tax-free or a surprise. These are the clauses that decide who is left holding the bag, and they are written, or fatally not written, at the start.

Inside this hub

Partnership taxation basics

When your LLC has more than one member, it is taxed as a partnership, and partnership tax is its own world. Pass-through income, outside basis, and the rule that you are taxed on paper profit you may never receive in cash.

Guaranteed payments vs distributive share

A partnership can pay a member two very different ways, and they are taxed differently. One is deductible to the partnership and carries self-employment tax; the other is just your slice of the profits. Confusing them is a common and expensive error.

Special allocations and substantial economic effect

A partnership can split income and loss in ways that do not track ownership, giving one partner the depreciation and another the gain. But the IRS only respects those splits if they pass a specific test, and a badly drafted agreement fails it.

Capital accounts

A capital account is each partner's running scorecard: what they put in, what they earned, what they took out. It sounds like bookkeeping, but it is the thing that makes special allocations valid and decides who gets what when the partnership ends.

The 754 election

When a partner buys in or dies, they pay full price for their share, but the partnership's tax basis in its assets does not move to match. A 754 election closes that gap, and skipping it can tax an heir twice on the same appreciation.

704(b) allocations

Section 704(b) is the rulebook that decides whether the IRS respects how your partnership splits income and loss. It is where capital accounts, the economic-effect test, and the special rules for debt-funded losses all come from.

704(c) built-in gain

When a partner contributes property that has already appreciated, the tax code makes sure the pre-contribution gain stays with them, not the other partners. Section 704(c) is how, and the method the partnership picks decides who really gets the depreciation.

Tax basis vs book basis

Partnerships keep two sets of books, and confusing them is the root of most partnership-tax mistakes. One tracks economics at fair value, the other tracks tax at carryover cost, and real estate keeps them apart on purpose.

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