Phantom Income Explained: The Hidden Costs of Limited Partnerships

For those whose day-to-day preoccupations exist outside of the technical and sometimes chaotic world of real estate partnership investment and acquisition, making meaningful financial use out of limited partnership holdings can be difficult as these holdings are frequently beset with complex tax issues. One such issue that we see time and time again is the presence of a phantom income on year-end schedule K-1 forms, a phenomenon that frequently besets limited partners, at times without their even having noticed.

Phantom Income as a tax phenomenon comes about as the result of the cessation of the depreciation of given long-standing tax shelter holdings, which results in a negative balance between the cash being paid out constructively to a limited partner and the taxes owed on the reported income of the holding. In the Late 1970s and early 1980s, a broad swath of affordable housing projects was developed with financial architecture that included tax sheltering opportunities for limited partners. As time has passed, and the depreciation on these holdings has run its course and thus the tax sheltering functionality has disappeared. For example, a limited partner might own 1.8% of a legacy affordable housing project, which in 2017 might yield $2,000 in cash dividends. Due to the complete deprecation of the holding, however, the taxes owed on the income, say $10,000 reported for the year, could easily exceed the dividends, leaving the limited partner in question with a net loss at year end despite a healthy reported cash flow.

This situation, when it occurs, is obviously undesirable to the limited partner, but the truly damning feature of these limited partnership holdings is that, due to their intricate design and undesirable tax status, they are very difficult to liquidate, which leaves limited partners trapped in a cycle of unending losses that can extend through their heirs and their estates. LP Equity has been working with limited partners for over a decade to aid in the liquidation of such burdensome limited partnership interests, we having created a secondary market within which the liquidation of such interest is possible. If you believe you or an associate may be beset with a real estate holding that is generating phantom income, please reach out to our team with any questions about how LPE can help you create immediate liquid cash on these holdings.

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