The Hidden State Tax Trap at Disposition
Fund managers spend months underwriting deals, negotiating terms, and planning exits. But many overlook one of the most painful pitfalls in real estate and private equity: state tax liabilities at disposition.
It happens more often than you think. A fund sells an asset, distributes profits, celebrates the win — and then gets blindsided by state tax bills. The money has already gone to LPs. The GP is left with two bad options: call capital back from investors or eat the cost themselves.
Either outcome destroys credibility.
Why State Taxes Get Missed
Most CPAs focus on federal tax. State-level exposure is treated as an afterthought. But when your fund operates across multiple states, tax liabilities are unavoidable.
Nexus rules vary by state. Some states trigger filing requirements if you own property. Others apply thresholds based on income or investor residency.
Gains on sale create liability. Even if your fund is domiciled in Delaware, California will tax gains on a property located there.
Investor residency matters. Many states require withholding or composite returns for investors who live in that state, creating filing obligations even if the fund itself has no property there.
Real-World Scenarios
A multifamily fund sells in California, distributes profits, and later gets a six-figure bill from the state. With no reserves, the GP is forced to absorb the cost.
A debt fund with out-of-state investors fails to comply with withholding requirements. LPs are forced to file in multiple states, creating a poor investor experience and damaging trust.
The Investor Relations Fallout
Investors don’t want to hear that their distributions are being clawed back to cover state tax obligations. In most cases, sponsors absorb the cost to protect relationships. That’s a direct hit to GP cash flow.
The larger cost is reputational. If your fund mishandles state tax obligations, investors start questioning your ability to manage risk. That makes capital raising harder, even when your returns are strong.
How to Avoid the Trap
Proactive State Tax Planning – Identify exposures across all states where your fund operates or where investors reside.
Build Reserves at Disposition – Hold back enough cash before distributions to cover expected state taxes.
Use PTET Elections – Pass-through entity tax elections can turn state taxes into deductible business expenses, bypassing the federal SALT cap. This is a major advantage in high-tax states like CA, NY, and NJ.
Coordinate With Counsel – Ensure your operating agreements and offering docs address state-level obligations.
Quarterly Projections – Incorporate state exposures into your quarterly planning. Waiting until April guarantees you’ll miss something.
Why Most CPAs Miss It
Box-checker CPAs focus on federal returns. They don’t model state exposures. They don’t coordinate with attorneys or administrators. They don’t tell you to reserve at disposition. By the time the state bill arrives, the damage is done.
A strategic advisor anticipates these issues and designs a battle plan that keeps both the IRS and the states out of your distributions.
The Bottom Line
Fund managers compete on credibility as much as returns. Getting blindsided by state taxes is one of the fastest ways to lose both.
We’re in September. There’s still time to review your exposure and build reserves before year-end. Don’t wait until April to find out you owe six figures.
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