Things to Know About REITs and PTPs
Markets have evolved to include diverse financial products that are much more complex for tax purposes. Some of the most complicated for taxpayers to handle are interests in entities that are not separately taxed. The tax information reported to taxpayers annually can be baffling to those unaware of the tax implications.
REITs (Real Estate Investment Trusts) are corporate entities for tax purposes that must satisfy certain requirements including holding qualifying assets and deriving income primarily from passive real estate investments. REITs are able to deduct distributions to unit holders to avoid an entity-level tax. Consequently, REIT owners report their share of the ordinary income and net capital gains that are distributed to them on their own return.
A Publically Traded Partnership (PTP) is a partnership whose interests are publicly traded and meet the “qualified income” requirement. A Master Limited Partnership (MLP) is a class of PTP. Some key items to note:
- Distributions are not separately taxable. Unitholders are taxed on their share of the partnership’s taxable income. Distributions will affect the holder’s tax basis in the security.
- Tax items are reported annually on Form K-1 to the unit holder. These K-1’s typically include multiple pages of detailed information regarding treatment of items on the K-1 as well as how to handle dispositions.
- Upon a sale of the units, a portion of the proceeds may be ordinary income rather than capital gain and can even turn a gain into a loss.
- Taxable income and distributions adjust the unitholder’s original cost basis for tax purposes. Brokers will only provide the original cost when reporting sales on a 1099B. Therefore, the correct tax basis must be calculated for dispositions. The methodology is disclosed in the notes to the K-1, and requires a calculation.
- Income is currently taxable but a loss in a given year is suspended and can be used only to offset the passive income from the same PTP in a subsequent year or on sale of the units.
- There are significant amounts of information in supplemental schedules and/or footnotes which is often complicated by the fact that certain MLPs may hold other PTPs as assets. In this case a separate calculation for each underlying PTP would be required.
- Certain deductions, i.e. depletion, have to be addressed by the unitholder on his return.
- Depending of the level of the unitholders’ investment, State level tax returns may be required to report the activities of the PTP.
Investors and their tax advisors need to be mindful of these issues and are well-advised to seek the assistance of tax advisors to ensure that the information is properly presented.
