Accounting Issues
Typically, though not always, all such private company offerings are structured as LLCs and LPs. The usual cautions apply. Specifically, "publicly traded" partnerships will be taxed as corporations, which can seriously reduce after-tax IRRs. You should decide whether competent accountants and attorneys are involved. Assuming the deal passes this hurdle, the following issues should be considered.

If the investor is a tax-exempt entity, unrelated business taxable income (UBTI) issues need to be considered. In the case of a real estate investment, the LLC or LP will often take on real estate mortgage debt. Under the tax code, typically first-mortgage real estate mortgage leverage will not trigger UBTI. Nonetheless, find out whether the entity will receive any "service income."  This might be the LLC operating a restaurant or providing personal services to tenants. Typically, if the service revenues are a small portion of total revenues, they will not trigger UBTI. Overhead and other costs will usually offset revenues and eliminate any profit. So there should be some language in the offering documentation that the manager will use commercially reasonable efforts to ensure that will not happen. Should the property generate UBTI for some reason, and should the investor be a tax-exempt entity, the member would be required to file a tax return and could incur a tax liability.

Investors among charitable remainder trusts (including charitable remainder annuity trusts and charitable remainder unitrusts), however, run a much greater risk. They are not exempt from taxation in any year in which they realize UBTI. In these cases, a trust's investment in an entity could trigger tax on all the trust's income in that year (including income from other sources). Given the potential for such disastrous results, these investments are generally not appropriate for charitable remainder trusts.

For certain taxable investors, there can be other benefits. Over the first ten years or so of a real estate transaction, the cash distributions will often be sheltered from tax by depreciation, and there may be excess passive losses that investors with passive income can use to offset that income.

Those financial advisors and wealth managers interested in doing the analysis may find that such private equity investments can give them opportunities to differentiate themselves, improve their performance and keep the loyalty of high-net-worth investors who are looking for ideas and execution that are more interesting and promising than investments available to those who are less wealthy.     

Michael Dowd is a senior vice president at MCM Securities in New York. He can be reached at [email protected].