The Offering Memorandum and the Operating Agreement: When They Don't Match

In a real estate syndication, investors receive two key documents: the offering memorandum (OM) and the operating agreement (OA). The OM describes the deal. The OA governs it. When the two documents describe the economics differently, the tax preparer has to determine which one controls. The answer is almost always the operating agreement.

What Does Each Document Do?

The offering memorandum is a marketing and disclosure document. It describes the investment opportunity, the expected returns, the fee structure, the waterfall, and the risks. It is what investors read before deciding to invest.

The operating agreement is the binding legal document. It defines the actual allocation provisions, distribution waterfall, fee arrangements, and tax elections. It is what the CPA follows when preparing the partnership return and the K-1s.

The OM is a description. The OA is the rule.

Where Do They Typically Diverge?

In a well-prepared syndication, the OM and OA should be consistent. But in practice, we see discrepancies in several areas.

Waterfall descriptions. The OM may describe the waterfall in simplified terms for investor readability. The OA may include additional tiers, catch-up provisions, or clawback language that the OM glosses over. The tax allocations follow the OA, not the simplified OM description.

Fee structure. The OM may describe fees at a high level (e.g., "2% asset management fee"). The OA may define the fee differently (e.g., based on a different calculation base, or paid in a different capacity). The tax treatment follows the OA language.

Allocation method. The OM may describe the expected returns and how profits will be split. The OA contains the actual allocation provisions. If the OM implies a simple percentage split but the OA uses Target Capital allocations, the K-1 will follow the OA.

Preferred return definition. The OM may describe a "preferred return" in general terms. The OA may define it in a way that could be classified as a guaranteed payment depending on the specific language used. The tax treatment depends on the OA.

Why Does This Matter for the Tax Return?

The tax preparer relies on the operating agreement to prepare the return. If they only have the OM, or if they follow the OM instead of the OA, the return may not accurately reflect the deal's tax provisions.

This is a common issue when a tax preparer is not given the operating agreement or does not read the allocation provisions carefully. The OM gives them a general sense of the deal, but the OA contains the specific provisions that drive the K-1.

What Should You Do?

If you are an investor, compare the OM to the operating agreement before you invest. Look at the waterfall, the fee structure, and the allocation provisions. If something in the OM does not match the OA, ask about it. The OA controls.

If you are a sponsor, make sure the OM and OA are consistent. Discrepancies create confusion for investors and for the tax preparer. Have the CPA review both documents together before the deal closes.

The Top 10 Items to Review covers the most common operating agreement provisions that affect the tax return. The Decision Matrix helps identify which allocation structure fits your deal.

This post is educational and does not constitute tax or legal advice. Consult your CPA or tax advisor for guidance specific to your situation.

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