Partnerships
As the name suggests, partnerships consist of two or more
partners who join together to acquire, operate and hold
real estate. It's an effective way of pooling capital and
talent. A key feature of a real estate partnership is that
the investors don't actually have the title or ownership
directly in acquired properties. Instead, they own a
partnership interest.
Partnerships usually take two forms—general and
limited.
General Partnerships
In this setup, each partner possesses the right to fully
participate in property management and operations.
General partnerships have the following advantages:
They're easy to set up and maintain. You don't have to
register with your state and pay fees, as you do to
establish a corporation or limited liability company (LLC).
You can file income tax returns with relative ease. This is
because a general partnership is normally a "pass through"
tax entity. This means the partners, not the partnership,
are taxed. Unlike a regular corporation, there's no need to
file separate tax returns for the corporate entity and its
owners. General partnerships offer flexibility. Partners
are able to set their responsibilities and benefits as they
see fit or as the needs of the business dictate. The
flexibility extends to distribution of profits and losses.
So, for example, an individual partner can reap higher
profits for taking on more financial risk.
A partnership is considered a "discrete' asset. Because of
this, it can be transferred to other people, heirs, or
estates unlike a sole proprietorship. Transference is
usually limited by the terms of the partnership agreement.
There's one primary disadvantage of general partnerships:
One business-related act of a partner can make all partners
legally liable for that act. So it's important that you
enter into partnerships only with people you trust. Then
back up that trust with a written partnership agreement
that establishes the following: each partner's share of
profits or losses, day-to-day duties, and what happens if
one partner dies or retires.
Limited Partnerships
This ownership form differs from a general partnership in
the role and responsibilities of the partners. It consists
of one or more general partners and one or more limited
partners. Typically, the general partners run the
operations of the business while the limited partners
provide capital and help arrange financing while not taking
an active role in running the business. In return for their
investment, they receive a share of the profits for their
involvement as limited partners.
Statutes regarding limited partnerships vary by state so
you'll have to check with the appropriate government agency
for a definition of the obligations and responsibilities of
partners in this type of business arrangement. The
partnership is required to file with the secretary of state
and must also file various reports.
A key feature of a limited partnership agreement lies in
the area of liability, which falls on the general partners,
and typically not on the limited partners. For this reason,
individuals are reluctant to be general partners.
The general partner of a limited partnership can itself be
a corporation or LLC to lessen liability issues. However,
this doesn't mean that a limited partner can't be part of,
or have a vote in, major decisions that affect the
partnership.
Here are the advantages of a limited partnership:
As a limited partner, you can invest even though you don't
have expertise or the time to devote to being a hands-on
part of the business. You can take on the financial risk
but not the liability risk. Partners are able to allocate
profits, losses and gains as they see fit, regardless of
the equity interest of a specific partner, subject to
compliance with tax laws. The general partners prepare an
IRS Form 1065 for the partnership. Each partner then
prepares his or her own tax form listing all profits,
losses and depreciations. It's a "pass-through" operation
with profits passing through to the partners who then
include their allocated income on their personal tax
returns. It's much easier to attract investors as limited
partners. It allows general partners to use their
expertise, make key decisions and manage the business.
Limited partners can leave the business or be replaced
without the need for the limited partnership to be
dissolved.
Disadvantages of a limited partnership include the
following:
Filings, formalities and state requirements mean a lot of
paperwork. If you're a general partner, you assume personal
liability. Limited Liability Companies (LLCs) This is
hybrid form of ownership that combines the properties of a
corporation and partnership. It has several advantages: It
provides the flexibility and tax advantages of a
partnership while maintaining the limited-liability
benefits of a corporation.
Like a corporation, an LLC is a separate legal entity that
limits the liability of its members. However, it has the
tax benefits of a partnership. LLCs are also free of many
of the legal requirements that govern corporations
(including annual reports, director meetings, shareholder
requirements and so on). LLCs are a "pass through" tax
entity, which means company profits and losses are passed
through the business and taxed solely on the members'
individual tax returns. Members can hire a management group
to run the LLC. This group can consist of members,
nonmembers, or a combination. Members can split profits and
losses any way they wish. Dividend distribution is
nontaxable, unlike an S corporation, where dividends are
taxable. An unlimited number of members may join a single
LLC, and most states allow single-member LLCs. An LLC may
affiliate with other businesses, unlike an S corporation,
where that ability is limited.
Disadvantages of LLCs include the following:
Costs can be greater. Some states impose income or
franchise taxes on LLCs or require LLCs to pay annual fees
to operate in that state. Lack of legal precedent. Because
LLCs have existed as legal business entities only since
1996, there's not much legal precedent available to help
owners predict how legal disputes may affect their
businesses. Every state has its own requirements so check
with an attorney who specializes in LLCs before deciding to
form or join a limited liability corporation.
In the next and final installment of this series, I will
discuss corporations. Both advantages and disadvantages.
Jack Sternberg
----------------------------------------------------
Jack Sternberg is a nationally recognized expert on real
estate investment and the creator of the renowned "Buyers
First Program" who's been in the business for more than 30
years. Jack Sternberg's deals have totaled over $750
million and he's been to the closing table more than 1,500
times. For more, visit http://www.askjacksternberg.com
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