Real Estate Title Holding - Part Two
Sternberg brings his "in the trenches" expertise after 30+ years as a real estate investor to the 2nd installment of this series. This article is a must read for any investor dealing with and understanding general title issues in real estate.
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 formsgeneral and limited.
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.
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.
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ABOUT THE AUTHOR
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