Partnership Representative: Who Handles an IRS Audit of Your Syndication (and Why It Matters)
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A syndication taxed as a partnership must name a partnership representative on its tax return every year, unless it validly elects out of the IRS's centralized partnership audit regime. Under these rules, created by the Bipartisan Budget Act of 2015 (BBA) and effective for tax years beginning in 2018, the representative has sole authority to act for the partnership in an IRS audit, and the partnership and every partner are bound by what the representative does. If the audit finds more tax, the IRS generally assesses it at the partnership level, unless the partnership pushes the adjustments out to the partners. Most apartment syndications can't elect out, so the operating agreement should spell out who the representative is and what they must do.
This guide explains the role for sponsors and for investors. For the broader document, see the syndication operating agreement.
What does the partnership representative do?
The IRS's partnership representative page says the representative has sole authority to act on behalf of the partnership in BBA audit procedures, and the partnership and partners are bound by those actions. That includes:
- Extending the time the IRS has to assess.
- Agreeing to proposed adjustments or contesting them.
- Requesting modification of the imputed underpayment (within 270 days of the notice of proposed adjustment, unless extended).
- Making a push-out election.
- Settling or going to court.
Investors have no automatic right under the federal rules to be notified of or take part in the audit. Any such right comes from the operating agreement.
Who should be the partnership representative?
In most syndications, it is the sponsor's management company or the deal's manager, with the sponsor named as the designated individual. Whoever it is must meet the substantial presence test and be reachable for years after the deal sells, since an audit can come long after the return is filed. The designation is made on the return for each year and applies only to that year.
Can a syndication elect out of the BBA audit rules?
Only if it has 100 or fewer partners and every partner is an eligible partner. Under the IRS election-out page, eligible partners are individuals, C corporations, foreign entities that would be C corporations if domestic, S corporations (counting each shareholder toward the 100) and estates of deceased partners. A partnership is ineligible if it must issue a K-1 to any partner that is a partnership, a trust, a disregarded entity, an estate other than a deceased partner's, or a person holding the interest for someone else.
In a typical apartment syndication:
- The sponsor's investing entity is often a multi-member LLC (a partnership) or a single-member LLC (disregarded).
- Investors invest through living trusts, single-member LLCs and self-directed IRAs (see investing through an LLC or trust and self-directed IRA investing).
Any one of those makes the election out unavailable. So plan on the deal being under the BBA rules.
What happens if the IRS finds more tax?
The IRS issues a notice of proposed partnership adjustment and, later, a final notice. By default the partnership pays an imputed underpayment, generally computed at the highest individual or corporate tax rate for the year under audit (26 U.S.C. 6225; see the IRS's BBA overview). Two things soften it:
- Modification. Partners can file amended returns or show that some partners are tax-exempt or taxed at lower rates, which can reduce the amount. The representative requests this on Form 8980.
- Push-out. Within 45 days of the final notice (no extensions), the partnership can elect to push the adjustments out to the partners of the year under audit, who then pay the tax on their own returns.
Without a push-out, the tax is paid with the partnership's money, in the year the audit ends. That burden falls on whoever is a partner then, which can be a different group than the one that got the benefit, for example after transfers or a sale.
What the operating agreement should say
- Who is the partnership representative and designated individual, and how they are replaced.
- That the representative must tell investors promptly about an audit notice, and send copies of key notices.
- Whether investors are consulted before the representative agrees to a settlement or extends a deadline.
- Whether the representative will make a push-out election, or how that is decided.
- That each investor must cooperate with modification (for example, filing an amended return) and give information the representative needs.
- How an imputed underpayment paid by the company is charged to the investors it relates to, including former investors, and whether they must repay it.
In DoorRaise's standard operating agreement, the Manager is the partnership representative, keeps members informed of a tax audit and gives each member a copy of any notice of proposed adjustment that affects it. If the company is assessed an imputed underpayment, the Manager may push it out to the people who were members in the year under review, or the company pays it and charges each member its fair share, taking into account who was a member in that year. Investors read the actual terms of each deal in its offering documents.
For investors: what to check before you invest
Read the tax section of the operating agreement for the items above, and ask the sponsor who the representative is and who prepares the return. See how to read a PPM for where these terms usually sit.
How DoorRaise fits in
DoorRaise helps sponsors raise equity for apartment buildings with 5+ units from their friends and followers under Rule 506(b) or 506(c). It prepares the standard offering documents, forms the LLC, files Form D and state notices, and verifies accredited investors for 506(c) deals. Escrow is at Enterprise Bank & Trust, an FDIC-insured bank, and investors fund by wire only. See pricing. DoorRaise is not a law firm, broker-dealer, investment adviser, funding portal or bank.
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FAQ
Is the partnership representative the same as the tax matters partner?
No. The tax matters partner was the role under the old TEFRA rules for tax years before 2018. The partnership representative has much broader authority and binds all partners.
Can an investor be the partnership representative?
Yes, if they meet the substantial presence test, but most syndications name the sponsor or its management company because the sponsor runs the deal and its records.
Do we need to file anything if there is no audit?
Yes. The designation is made on each year's Form 1065. If the deal can elect out, the election is also made each year on Schedule B-2 of a timely filed return.
Does a push-out cost investors more?
Partners who receive a push-out statement pay the tax for the reviewed year on their own returns, and interest under push-out rules is figured at a rate 2 points higher than the normal underpayment rate. It puts the tax on the people who were partners in that year.
Next step: see what investors receive each tax season in the K-1 in a real estate syndication.
Sources
- IRS: BBA centralized partnership audit regime
- IRS: Designate or change a partnership representative
- IRS: Elect out of the centralized partnership audit regime
- IRS: BBA partnership audit process
- 26 U.S.C. 6221, assessment at partnership level
- 26 U.S.C. 6225, imputed underpayment
- 26 U.S.C. 6226, alternative to payment of imputed underpayment
This article is general information, not tax or legal advice. Talk to a CPA and a tax attorney about your deal. DoorRaise is not a law firm, broker-dealer, investment adviser or funding portal.