Understand how your real estate partnership activity translates into the figures reported on your Schedule K‑1 tax form.
For new real estate investors, receiving a Schedule K‑1 can feel like getting a report card written in a foreign language. At its core, the Schedule K‑1 reports your share of a partnership’s income, losses, deductions, and distributions. As real estate fund structures have grown more sophisticated, the accompanying footnotes and attachments often provide detail that goes far beyond the summary boxes on the form.
Before diving into the complexities, it’s important to understand what a Schedule K‑1 represents. It is not a performance statement, nor does it measure market value or economic returns such as internal rate of return or cash‑on‑cash metrics.
The purpose of the Schedule K‑1 is simply to report what flows to your tax return. Your investor reporting tells the economic story; your Schedule K‑1 tells the tax story.
The role of leverage and interest deductibility
Because real estate investments commonly use leverage, interest deductibility plays a key role in partnership tax reporting. Under the One Big Beautiful Bill Act (OBBBA), the business interest limitation once again relies on an EBITDA‑based calculation, generally increasing the amount of interest a partnership may deduct. Supporting statements to the Schedule K‑1 typically disclose both the interest currently deductible and any amounts carried forward.
Partnerships must also consider whether to elect out of the Section 163(j) business interest limitation. This election can be appealing for highly leveraged projects because it permits full current‑year interest deductibility. However, it comes with a meaningful trade‑off: partnerships making the election must use the Alternative Depreciation System (ADS) for certain assets, which lengthens recovery periods and eliminates bonus depreciation for those property classes. Currently, once made, the election is irrevocable.
Debt basis, liability allocations, and loss utilization
The reliance on debt in real estate partnerships affects investors not only through interest deductibility but also through the allocation of partnership liabilities. These allocations determine each partner’s debt basis, which allows investors to deduct losses that exceed their cash contributions.
When depreciation and interest deductions generate taxable losses, the ability to use those losses often turns on whether the investor has sufficient basis. As a result, loss deductibility can vary significantly from year to year, or between investors in the same deal, depending on how the partnership’s debt is structured and allocated under the partnership agreement.
Debt basis also affects the tax treatment of distributions. Returns of capital generally require a partner to have adequate basis, and when basis is reduced by large depreciation deductions or interest expense, distributions can become taxable sooner than expected. These impacts are typically reflected in the Schedule K‑1 footnotes or supplementary schedules.
Depreciation, bonus rules, and how taxable losses occur
For property not subject to ADS, OBBBA restored 100% bonus depreciation for eligible assets acquired and placed in service after January 19, 2025. As a result, investors may continue to see additional depreciation deductions, particularly for other property such as office equipment, office furniture, vehicles, and machinery.
Investors sometimes expect large first‑year bonus depreciation but instead see lower deductions when ADS applies. Conversely, they may be surprised to see substantial taxable losses even when the investment is generating positive cash flow. This disconnect reflects the structure of the tax code, which encourages real estate investment through accelerated cost recovery and interest deductibility. It is common for taxable income to be negative despite strong property‑level operating performance.
The permanence of the Section 199A deduction
Another long‑term benefit for real estate investors under OBBBA is the permanent 20% Section 199A deduction for Qualified Business Income. Calculating this deduction requires two key pieces of information from the partnership: the Unadjusted Basis Immediately After Acquisition (UBIA) of qualified property and each partner’s share of W‑2 wages. These figures affect both eligibility for the deduction and its amount.
Capital accounts, basis tracking, and the gap between tax and market value
The IRS places significant emphasis on accurate capital account and basis reporting. The Schedule K‑1 instructions outline how these amounts change each year based on contributions, distributions, and allocations of income or loss. Still, it is important to remember that tax basis is not the same as fair market value. With accelerated depreciation and interest deductibility, negative tax capital accounts have become more common, even when the underlying real estate is performing well and appreciating.
Investor reporting reflects the economic reality of the investment; the Schedule K‑1 reflects how federal tax law characterizes that same activity.
What new investors should take away
A Schedule K‑1 is fundamentally a compliance document, while investor reporting is a performance document. The footnotes and supplemental pages that accompany the Schedule K‑1 function as the bridge between the two, explaining how the numbers were calculated and how they fit within partnership tax rules. Understanding this distinction helps investors interpret their Schedule K‑1s accurately and reduces confusion when tax results differ from economic outcomes.
How CLA can help
CLA’s real estate professionals combine technical tax knowledge with deep industry expertise to help investors make sense of their Schedule K‑1s. Our team translates complex tax concepts into clear and practical guidance, helping investors understand how partnership‑level decisions affect their individual returns and how tax reporting aligns with the broader economic picture.