Selling Your Syndication Interest: Section 751 Hot Assets, Form 8308 and Your Tax Bill

On this page

1. What are "hot assets" in an apartment syndication?
2. A worked example (made up)
3. What forms are involved?
4. Other tax effects of selling
5. Before you sell
6. How DoorRaise fits in
7. FAQ

If you sell your interest in an apartment syndication before the property sells, your gain is not all long-term capital gain. Under Section 751, the part of the gain that comes from the partnership's "hot assets" is taxed as ordinary income. In an apartment deal, the main hot asset is usually depreciation recapture on personal property and land improvements that a cost segregation study broke out. Part of the rest can be unrecaptured Section 1250 gain from the building, taxed at a maximum 25% rate, and only what is left is regular long-term capital gain. You must notify the deal company of the sale; the company then files Form 8308 and reports the split to you on your K-1 in box 20 with codes AB, AC and AD, according to the IRS instructions for Form 8308.

This guide explains how the gain is split, what forms are involved and what to ask before you sell. For how to find a buyer and the transfer rules, see selling a syndication interest.

What are "hot assets" in an apartment syndication?

Section 751 treats two kinds of partnership property as hot: unrealized receivables and inventory items. "Unrealized receivables" include the depreciation recapture that would be ordinary income if the partnership sold its assets. In an apartment deal:

• Section 1245 recapture on personal property and land improvements that were depreciated over 5, 7 or 15 years, often with bonus depreciation after a cost segregation study, is the big one.
• The building itself is Section 1250 property. Its depreciation produces "unrecaptured Section 1250 gain", which is not ordinary income for most residential buildings but is taxed at a maximum 25% rate.

To find your share, the partnership computes the gain or loss it would have if it sold all its property for fair market value in a fully taxable transaction, then allocates your share.

A worked example (made up)

The numbers below are invented to show how a gain splits.

• You sell your interest for $140,000. Your adjusted basis (including your share of the deal's debt, which the buyer takes over) works out to a gain of $80,000.
• The partnership's deemed-sale calculation shows your share of Section 1245 recapture is $25,000: that part is ordinary income under Section 751.
• Your share of unrecaptured Section 1250 gain is $30,000, taxed at up to 25%.
• The remaining $25,000 is long-term capital gain if you held the interest more than a year.

Your actual split depends on the deal's depreciation, the property's value and your capital account. Ask the sponsor for an estimate before you agree on a price.

What forms are involved?

• Your notice to the partnership. The seller must notify the partnership in writing of the exchange, with the names, addresses and tax ID numbers of both parties and the date, so the partnership can report it.
• Form 8308. The partnership files a separate Form 8308 for each Section 751(a) exchange, attached to its Form 1065, and furnishes copies to the seller and the buyer by January 31 of the following year or, if later, 30 days after it learns of the exchange.
• Schedule K-1, box 20. The partnership reports your Section 751 gain (code AB), collectibles gain (code AC) and unrecaptured Section 1250 gain (code AD).
• Your return. You report the sale, with the ordinary portion and the capital portion, using the partnership's figures. If the Form 8308 and your K-1 disagree, use the K-1 and ask the partnership.

Other tax effects of selling

• Suspended passive losses. Selling your entire interest in a fully taxable sale to an unrelated buyer generally frees up suspended passive losses from that activity. See passive loss carryovers.
• Net investment income tax may apply to the gain. See NIIT for syndication investors.
• State tax may be due where the property is. See state tax returns for nonresident investors.
• The buyer's basis. If the partnership has a Section 754 election, the buyer can get a basis adjustment. See the Section 754 election.

Before you sell

1. Read the operating agreement's transfer rules and get the manager's consent.
2. Ask the sponsor for your capital account, your share of liabilities and an estimate of your Section 751 and unrecaptured Section 1250 amounts.
3. Ask your CPA to model the tax on the sale price you are considering.
4. Notify the partnership in writing right after the sale, with the details it needs.

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). Investors see their documents, distributions and K-1s in one place, and the deal's accountant prepares the tax filings. 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, and gives no tax advice.

Ready to raise? Create your free sponsor page or see pricing.

FAQ

Is the gain from selling my syndication interest a capital gain?

Mostly, but not entirely. The part from hot assets is ordinary income under Section 751, and the part from building depreciation is unrecaptured Section 1250 gain taxed at up to 25%.

Does this also apply when the deal sells the building?

When the partnership sells the property, similar recapture rules apply at the partnership level and flow to you on your K-1. Section 751 matters specifically when you sell your interest instead.

What if the partnership never sends Form 8308?

The partnership must file once it has notice of the exchange. Make sure you sent written notice with the required details, and ask the sponsor for the form and your K-1 box 20 amounts.

Does the buyer have to be accredited?

Transfers must comply with securities laws and the operating agreement. Sponsors usually require the buyer to meet the same investor standards as the original offering.

Next step: see how the final numbers look at the deal's own exit in K-1 box 10 and Section 1231 gain.

Sources

• IRS: Instructions for Form 8308
• IRS Publication 541, Partnerships
• IRS Partner's Instructions for Schedule K-1 (Form 1065)
• 26 U.S.C. 751, unrealized receivables and inventory items

This article is general information, not tax or legal advice. The example is made up to show how a gain splits. Talk to a CPA before you sell. DoorRaise is not a law firm, broker-dealer, investment adviser or funding portal.