New Section 514(c) Fractions Rule Guidance for Exempt Orgs: Avoiding UBTI in Real Estate Partnership Investments

Description

The partnership “fractions rule” of Section 514(c)(9)(E) has a well-deserved reputation among tax advisers and counsel as an intimidating tax trap for exempt organizations investing in real estate partnerships. The rule represents the intersection of UBTI and partnership allocations and creates a significant challenge to partnerships in designing appropriate allocations. This often discourages exempt organizations from investing directly in real estate partnerships, particularly those with debt financing.

The rule generally provides that partnerships with “qualified organizations” as partners may not allocate a percentage share of partnership income to a qualified organization in any year that is higher than their share of overall partnership loss in any tax year where such share of the loss is the smallest. All partnership allocations must also have “substantial economic effect” within the meaning of Section 704(b)(2). However, the multiple exceptions in the Section 514(c)(9) rules and regulations make applying the rules particularly complex.

The IRS recently issued proposed regulations to simplify the tax burden on exempt organizations investing in real estate partnerships. Under the proposed regulations, partnerships would be allowed to make allocations consistent with common business practices, although some questions still remain. The changes are generally taxpayer-friendly and may (if finalized) provide opportunities for reduced tax liabilities for exempt organizations that invest in fractions-rule compliant partnerships. Tax advisers must understand the application of the regulations to avoid costly tax consequences.

Listen as our experienced panel of exempt organization advisers provides a thorough and practical guide to navigating the complexities of the fractions rule in light of the proposed regulations.