Understanding the GAAP and Tax Differences Between Syndication and Organization Costs for Private Equity and Real Estate Private Equity Funds

June 22, 2020

By Tami Davidman and David Rackman

When a new private equity or real estate private equity fund is formed, generally the two most significant expenses incurred initially are for organizational costs and syndication costs. The treatment of these expenses under accounting principles generally accepted in the United Stated (“U.S. GAAP”) and the Internal Revenue Code (“Federal Income Tax”) can differ. An organizational cost or expense is the initial cost incurred to create a fund. Organizational costs usually include professional fees incurred to form the fund. This can include expenses incurred by attorneys to draft the fund’s governing documents.  Syndication costs are those incurred to market or sell an interest in the fund. These costs can include printing marketing materials and paying commissions to a broker who identifies investors for the fund, in addition to professional fees incurred in connection with the issuance and marketing of interests in the fund.

Organization costs are generally incurred prior to the fund’s commencement of operations, whereas syndication costs can continue through the fund’s offering period.

The table below indicates the accounting treatment under U.S. GAAP as compared to Federal Income Tax:

  U.S. GAAP Treatment Federal Income Tax Treatment
Organizational Costs Expense as incurred. Nondeductible, unless an election is made whereby the partnership may deduct up to $5,000 (reduced dollar for dollar where costs exceed $50,000), with the remainder being capitalized and amortized over 180 months, beginning with the tax year in which the trade or business begins.

It can be more advantageous to not make the election in some scenarios.
Syndication Costs Closed-end funds: Recorded as a contra-equity account and remains there through the life of the fund. In effect, this reduces net assets but is not recorded as an expense.

Open-end funds or closed- end funds with continuous offering period: Capitalized and amortized over 12 months on a straight-line basis.
Reduces equity within the fund. However, it does not reduce “outside” tax basis, thus creating a difference between “outside” tax basis and tax capital accounts.

 

About Tami Davidman

Tami Davidman is a Senior Audit Manager with experience managing engagement teams that perform audit services for clients in a variety of industries, including life sciences, financial services, and employee benefit plans.

About David Rackman

Mr. Rackman is a Tax Manager in the Real Estate Private Equity Group with 5+ years of experience in the tax aspects of partnerships. He also provides tax compliance, planning, and advisory services to high net worth individuals and families.

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