Outsized Depreciation Allocations: The GP Advantage
Depreciation is often treated as a passive benefit for LPs. But when structured correctly, it can be one of the most valuable tools for GPs. Sponsors who understand how to capture outsized allocations of depreciation can dramatically reduce their personal tax bill, improve fund performance, and better align the taxable income of the project with the actual economics.
Most CPAs miss this entirely. They focus on preparing K-1s, not designing fund documents. And because of that, many GPs lose one of the biggest advantages available in the tax code, an advantage that can create six- or even seven-figure savings over time.
At Stonehan, we help fund managers turn this overlooked opportunity into a deliberate part of their tax strategy.
The Real Challenge for Fund Managers
Most fund managers are motivated by one thing: growing their assets under management while keeping more of what they earn. But they face recurring pain points when it comes to taxes:
Taxes erode promote income. Even a well-structured promote can lose up to 40% to taxes when not optimized.
Limited depreciation use. Most GPs invest only a small amount of equity, meaning their share of depreciation is minimal.
Missed opportunities in fund documents. Attorneys and accountants often draft agreements without integrating tax allocation strategy.
Reactive accounting instead of proactive structuring. By the time K-1s are issued, the opportunity to reallocate depreciation is gone.
The truth is, GPs often overpay because their fund wasn’t designed with their own tax position in mind. Outsized depreciation allocations fix that, legally, effectively, and with full IRS support when done right.
How Depreciation Works in Practice
When a fund acquires a property, a cost segregation study breaks the building into components. With bonus depreciation still available under the OBBBA, roughly 20–30% of the purchase price can often be deducted in year one.
LPs receive their proportional share of depreciation.
GPs, however, can be allocated depreciation that reflects their promote, not just their co-invest.
A GP who invested 1–5% of the equity might still capture 30% of the year-one deductions if the fund is structured with a 70/30 split.
This isn’t aggressive. It reflects the economics of the deal and follows the rules under Section 704(b) of the Internal Revenue Code.
That’s the GP advantage: more real, usable losses allocated to the person who can actually use them.
Why LPs Often Don’t Use It All
Many LPs, especially high-income W-2 investors, can’t fully utilize real estate losses. Their depreciation allocations often go unused, sitting as suspended losses on their returns.
That inefficiency creates an opportunity. By shifting more depreciation to the GP:
The partnership as a whole pays less tax.
LPs still receive strong after-tax returns.
The GP captures real, usable deductions.
This is what alignment looks like. LPs benefit from improved after-tax yield, while GPs gain immediate tax relief they can use to reinvest in the next deal.
The Role of Fund Docs and Section 704(b)
Allocating depreciation isn’t as simple as updating a spreadsheet or revising a K-1. It requires careful design in the operating agreement and fund documents, including:
Properly drafted operating agreements. These must clearly reflect the economic deal between partners.
Compliance with Section 704(b). Allocations must have “substantial economic effect” to hold up under audit.
Mechanisms like qualified income offsets or minimum-gain chargeback provisions. These help the structure withstand IRS scrutiny.
If these elements aren’t built into your fund from the start, the IRS can reallocate losses, leaving both GPs and LPs exposed to back taxes and penalties.
And this is where most CPAs fail. They prepare returns but never look at the operating agreement. They don’t coordinate with attorneys. They don’t ensure the economics match the tax allocations.
That’s the Stonehan difference, we don’t just file returns. We design **tax strategies that are baked into your fund documents from day one.
Real Benefits for General Partners
When structured correctly, outsized depreciation allocations can create immediate and long-term advantages:
Direct personal tax savings. Capture deductions proportional to your promote, not your co-invest.
Improved investor pitch. LPs appreciate GPs who can explain how the fund structure reduces the overall tax burden for everyone.
Increased liquidity. Fewer taxes mean more after-tax cash flow, capital that can be reinvested into the next fund or deal.
Audit readiness. Allocations backed by legal and tax documentation stand up to scrutiny.
Alignment with fund economics. The structure reflects the true promote arrangement, not a one-size-fits-all allocation.
For many fund managers, this is the missing link between earning and keeping more.
Timing Is Critical
If you’re drafting new fund documents or reviewing existing ones, the time to address depreciation allocations is before year-end. Once the year closes, you can’t retroactively adjust allocations or restructure the fund for that tax year.
By December, the window for restructuring your strategy will close. Waiting until tax season means it’s already too late.
This is the season when proactive fund managers set up next year’s wins. Don’t wait until filing season to realize what could have been deducted.
Frequently Asked Questions
Q: Isn’t allocating more depreciation to the GP considered aggressive or risky?
A: No. When done under Section 704(b) with proper documentation, it’s fully compliant. The IRS only challenges allocations when they lack “substantial economic effect,” meaning they don’t match the economic deal of the partnership.
Q: Do LPs lose out when more depreciation goes to the GP?
A: Not necessarily. Many LPs can’t use their full allocation anyway due to passive-activity loss limitations. By shifting depreciation to the GP, the partnership often pays less tax overall, improving net returns for all investors.
Q: Can this be implemented in an existing fund?
A: Possibly, depending on your operating agreement and timing. Often, the best time to implement this structure is when forming a new fund or amending documents before year-end.
Q: What kind of savings can a GP expect?
A: It varies by deal size and structure, but capturing 20–30% of year-one depreciation can offset hundreds of thousands in taxable income, sometimes even more in large portfolios.
Final Takeaway: Strategy Over Compliance
The difference between a CPA who files taxes and a strategist who engineers outcomes is millions in retained wealth over a career.
Depreciation allocation isn’t a loophole, it’s a reflection of your fund’s true economics. When structured intentionally, it’s one of the most powerful levers GPs have to reduce taxes, improve investor alignment, and reinvest faster.
Most accountants just explain what’s allowed.
At Stonehan, we build strategies that put those laws to work for you.
Act Before Year-End
If you’re reading this before December 31, there’s still time, but not much. Once the calendar flips, your ability to restructure depreciation allocations for this tax year is gone.
📆 Book your Tax Strategy Call with James before year-end to:
Review your fund documents for hidden inefficiencies
Capture 2025 depreciation allocations the right way
Align your promote and partnership economics with the tax code
At Stonehan, we’ve structured billions in fund documents for sponsors and fund managers who want to keep more of what they earn.
Your year-end tax advantage depends on what you do next.
