You have invested in an “Alternative Investment”. It is a hedge fund of funds. The partnership in which you invested has in turn invested in 20 or 30 other hedge funds in order to diversify over different strategies and asset classes and minimize risk.
Your hedge fund is required to aggregate all items of income and deduction from all of the underlying hedge funds and maintain the tax attributes reported by each underlying Fund. Similarly, you must be provided with the same supplemental information reported on the Schedule K-1 of each underlying partnership. This might include, for example, passive and non-passive income and loss, investment interest expense deductible as an itemized deduction or as a non-passive deduction, net investment income, state sourced income, separate PTP loss information, investments in foreign corporations and foreign partnerships requiring disclosures, tax shelter reporting disclosure information, annual PFIC information, disposition of PFIC information and a dozen other footnotes giving additional information.
A hedge fund of funds Schedule K-1 can easily be 40 or more pages. As an investor, how do you know what to report, what is relevant, what does not apply to you, and where to find the items you must report?
We have consolidated and combined most of the important information and amounts to be reported on a single page, user-friendly, Schedule K-1 Summary which also tells you where to report this information on your individual return.
One of the challenges in preparing a fund of funds K-1 is that different underlying hedge funds, or their accounting firms, can put the same item in different places on a Schedule K-1. For example, you could have qualified dividend income shown on line 6B or alternatively on line 1, or alternatively on line 11F. The Summary K-1 indicates the combined total of qualified dividend income and also indicates that it consists of amounts from line 6B, line 1 and Line 11F. A note on the Summary K-1 indicates that you must see the Schedule K-1 footnotes for the amount of foreign qualified dividend income.
Another example would be that the Summary K-1 indicates the amount of non-passive income or loss reported throughout the Schedule K-1 on lines 1, 2, 3, 11A, 11F, 13J and 13W. However, if any underlying passive activity is from a Publicly Traded Partnership, it indicates that those items must be carved out from the total, separately reported and be subjected to separate passive loss limitations.
The Summary K-1 refers you to the Schedule K-1 footnotes for such items as:
- Foreign qualified dividend income
- State sourced income and withholding
- Tax exempt income by estate
- Effectively connected income for foreign partners
- Reportable transaction disclosure information
- Form 926 requirements for reporting a partner’s share of transfers to foreign corporations
- PFIC information under IRC Secs. 1291-1296
There are some items reported in only one place on the face of the Schedule K-1 which do not require combinations. The Summary K-1 identifies these items.
Examples would include:
- Tax preference items
- Foreign source income and deductions
- Foreign taxes paid
All items on the Summary Schedule K-1 are footed and the total ties back to Total Income (Loss) in the capital reconciliation schedule following the Schedule K-1.
We can prepare a User-Friendly Summary K-1 for your Fund of Funds.
Click here for a sample of the User-Friendly Summary K-1.
Ken Wolosoff can be reached at firstname.lastname@example.org or 516-240-4285.