A K-1 with near zero depreciation in year three of a medical office fund deserves a harder look than the sponsor usually gives it

Question

Passive investors in medical office funds generally expect the first few K-1s to carry meaningful depreciation. A cost segregation study in year one, with bonus depreciation flowing through and a paper loss that offsets other passive income, is the pattern most LP positions follow. So it is worth pausing when one position breaks that pattern. Take a 2021 vintage MOB fund holding 68,000 square feet across two suburban buildings, say in a Nashville submarket, where the 2023 K-1 shows essentially no depreciation and the prior two years looked the same. A sponsor in that spot will often say the properties are held for investment under a long term basis schedule and that the depreciation profile normalizes over time. Anyone who has read enough K-1s knows that answer is not an answer. A CPA looking at that fact pattern will usually land on one of two explanations. Either the cost segregation study was never done, or it was done and produced almost nothing, which happens with older buildings when a prior owner has already burned through the accelerated components. Buildings of 1998 and 2003 vintage fit that profile. The harder question is whether the sponsor owed disclosure before capital was wired. PPM language such as depreciation benefits available to investors reads like a promise and functions like nearly nothing. It commits the sponsor to no specific number and no specific method, and most subscription documents give an investor nothing firmer to point to. I would like to hear from anyone who has seen flat or near zero depreciation in years two and three of a MOB fund, and whether they were able to get anything from the sponsor beyond reassurance.

priya_n21 · Answer

Your CPA is right that the PPM language is essentially decorative. "Depreciation benefits available" is not a representation of method or magnitude, and sponsors know that when they write it. The 1998 and 2003 vintage issue is the real problem. If the prior owner held those buildings for 25 years and ran a cost seg themselves, the short life components like electrical, HVAC, finishes, and land improvements are already fully depreciated and you are inheriting straight line on whatever basis is left in the 39 year bucket. Nothing about that is fraud. It is simply a bad deal for a passive investor who bought in expecting front loaded losses. The thing to know before doing anything with this is what the allocated purchase price per building was and how much of that basis is sitting in personal property versus structure on the depreciation schedule the fund actually filed. If 90 plus percent is in the 39 year bucket, your CPA's suspicion is confirmed, the cost seg either was not done or was useless, and you will see nothing meaningful until year 38.

petrov_dan · Answer

Your CPA is doing you a favor and also telling you what you already suspect: you were marketed a tax story the asset could not deliver. 1998 and 2003 vintage means prior owners ran cost seg years ago, the short-life components are gone, and whatever basis is left sits on a 39-year straight-line schedule. The disclosure question is worth pushing, though there is almost certainly a paragraph buried in the risk factors saying depreciation benefits depend on asset characteristics and are not guaranteed. That language is close to standard. Pull the full PPM and search depreciation before deciding whether this is a fight worth having. The practical move is to stop waiting for the sponsor to normalize something that structurally cannot normalize without a major capital improvement triggering new basis, and to rebalance the other passive positions to compensate.

hannah_west29 · Answer

With 1998 and 2003 vintage buildings, the prior owner likely burned the components, and your CPA is probably right. The same pattern shows up on a 2004 vintage industrial building where the sponsor implied depreciation without ever committing to a method. An LP in that position can lose roughly $14,000 in passive loss offsets over two years simply because nothing was pinned to a method in writing before closing. "Depreciation benefits available" is a marketing sentence and carries no structural commitment. Ask for the actual cost seg report rather than a summary, and if they stall that tells you what you need to know.

gustavo_paredes · Answer

What did the PPM say, if anything, about whether a cost seg study would actually be commissioned post-acquisition, or did it just use that vague "depreciation benefits available" line with nothing more specific behind it?

Because the disclosure question lives right there. If they never committed to running a study, they technically told you nothing false, they just let you assume. That's legal and it's also a garbage way to run a fund.

victor_lam · Answer

The "depreciation benefits available to investors" language is filler. Sponsors use it because it is technically true at some level and creates no real obligation, and almost nobody challenges it because the amounts feel abstract until you are three years in with nothing to show. The vintage issue is real, though it is not the whole story. A 1998 shell can still have rooftop HVAC, specialized medical gas lines, procedure room finishes and parking canopy components that segregate fine even with a prior owner in the picture, and a competent sponsor on a 2021 acquisition should have ordered a study at closing to find out what was left. If the acquisition-year depreciation schedule shows straight-line 39-year on the full basis with no component breakdown, the cost seg was never ordered, full stop. The question worth answering before you decide whether to stay or push harder is whether the fund has a refinance or sale planned in years five through seven, because if so the sponsor may be banking on a step-up event to give you a depreciation story at exit, and that is a very different deal from what most LPs think they are buying into.

A K-1 with near zero depreciation in year three of a medical office fund deserves a harder look than the sponsor usually gives it

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