50/50 Partnership legal costs and depreciation benefits?

[Greg Baker]

Hi everyone, few questions, I'm in New York if it matters. I'm in the process of researching to purchase my first buy and long term hold. I'm considering partnering with someone 50/50 to make the first purchase less impactful on my family's finances and also in the event that we learn some hard lessons it will not be as financially painful. The properties I'm considering would be in the $60,000 range, conventional 25% down, with property management. I'm really trying to determine if partnering to "save" $8,000-$10,000 is really worth it with the additional costs I'm going to ask about below: 1. Any estimated cost to have an attorney draft up the legal contract between my partner and I covering everything including all the "what ifs?" 2. I was not planning to form a LLC, would this be more of a requirement with a partnership? If so, estimated cost to set up the LLC and annual cost? 3. How do the tax benefits of depreciation work when there are two partners who both put in 50/50 and are both listed on the mortgage? #3 is really important to me because I'm paying my six figure school loans back with income based repayment (IBR) and will utilize public service loan forgiveness in about 8 years. I'm hoping the depreciation will help offset annual raises at work and keep my monthly income based loan payments from spiking. Thanks, Greg

[Wayne Brooks]

You don't need an LLC, and it would make financing harder. Don't count on a tax loss at the end of the year, unless it is a really Lousy investment.

Rough yearly numbers, your depreciation will be about 3% total of purchase price.  Your principal reduction, which is not deductible, will be about 1.5-2.0% of mtg amount/year for the first 5 years.  So, if you have an exact "break even" cash flow, your deduction would be about 1-1.5% of purchase price per year.  And obviously, you're not hoping for a break even cash flow.

[Dave Toelkes]

With a partnership, the partnership will complete a partnership income tax return.  The partnership will take 100% of the depreciation expense to offset rental income.  Your share of the NET partnership income/loss will be reported to you on a Schedule K-1.  You use the Schedule K-1 to report your partnership income/loss on your personal income tax return.

If your student loan payments are based on the amount of discretionary income, then a depreciation expense for your rental property will not affect the amount of discretionary income.  Consult your financial aid counselor for specific details.

[Chris Martin]

To add to the above posts, if you go the route of an LLC/partnership you can set your

share of profit, loss, and capital any way you and your partner negotiate. See Line J of the K-1. SO a 50/50 "deal" may be for capital contributions and distributions, but your profit ratios can be 75/25... or whatever you, your partner, and your accountant(s) feel is the best mix for the LLC members. Seek advice from your accountant or tax expert....

[Greg Baker]

Thanks for the advice everyone, that definitely clears a lot up for me.  It sounds like this will be my last year (week) to have TurboTax as my tax expert...

[Dave Toelkes]

@Greg Baker 

You will have to explain your comment.  TurboTax is not a tax advisor, but rather, a tax preparation software package.  None of the questions you asked could be effectively answered by the TurboTax software, or its related tax estimation product, TaxCaster.  Now, if you are talking about the TurboTax Live Community, you probably would have gotten the same responses you got here.

[Greg Baker]

@Dave Toelkes 

Hi Dave, sorry, my joke/sarcasm did not translate well!  My comment was, until this point, I've just done my taxes myself using Turbotax, but moving forward, I'll definitely have to utilize a tax adviser.  Thanks again for your expertise.

[Craig Rismiller]

Off topic, but I am not a huge fan of partnerships when buying buy and hold properties. Here are a couple of reasons:

- You are both likely going to have to personally sign the loan. Though this may not seem like as issue now, being 50% of a conventional loan still counts against your Fannie / Freddie max loans

- Even though it may seem 'less risky' having a partner, you are likely still 100% liable for the debt if things go bad and your partner can't come up with cash. In general, I hate being liable for 100% of something and only getting 50% of the reward

- Partnerships are like marriage...so you better know each other's roles or eventually there will be trouble / bad feelings. If you both are bring money, credit and minimal experience - then from the surface I am not sure the value of a partner. It is almost like the blind leading the blind

You would think from the above I am not in any buy and hold partnerships but that isn't true. I have two:

- Phoenix: We are 50/50 money partners and 50/50 owners. I manage the books / finances / tenant screening and partners do property management / boots on the ground. This works really well as we are both getting something the other doesn't have / do well

-Midwest: Again 50/50 partners. I provide 100% of the cash for the deals and partner locates, rehabs, manages free of charge. I would only do 50/50 because the partner is adding so much value during the rehab and we hope to be close to no cash outlays after a portfolio refi.

I am not trying to discourage you from real estate but I do encourage you to really think of this will be a good longer-term fit or if you should fly solo.

[John Geldert]

@Craig Rismiller 

Excellent points, I am in the beginning stages of forming a 50/50 partnership with a long time friend. He will be supplying 100% of the capital and I will doing everything else, so basically he will be a silent, cash partner. Any thoughts on this venture or how we should structure it?

[Chris Martin]

Originally posted by @John Geldert:

@Craig Rismiller 

Excellent points, I am in the beginning stages of forming a 50/50 partnership with a long time friend. He will be supplying 100% of the capital and I will doing everything else, so basically he will be a silent, cash partner. Any thoughts on this venture or how we should structure it?

So... I assume 50/50 from a P/L (Profit and Loss) standpoint and 100/0 from a capital standpoint. Your partnership agreement should identify how capital distributions work if you as the 0% capital contributor are going to 'profit' from a future sale. E.g. members entitled to 50/50 untaxed distribution after accounting for 100% return of capital to capital contributors, all outstanding costs of sale, accrued taxes (? LTCG, etc.), etc... Nothing like writing it down up front via your partnership agreement.

[Alex M.]

Originally posted by @Craig Rismiller:

-Midwest: Again 50/50 partners. I provide 100% of the cash for the deals and partner locates, rehabs, manages free of charge. I would only do 50/50 because the partner is adding so much value during the rehab and we hope to be close to no cash outlays after a portfolio refi.

 Hi Craig - I'm looking into a similar partnership right now, where I am the locate, rehab, manage guy. Can you provide any additional details as to what worked well for you and what did not. I'm very interested in understanding the split around repairs and CapX over the lifetime of the investment. Right now, I would be interested in coming to agreement with my finance partner on a set aside (10% repairs, 10% CapX, 10% property mgmt - I do it, 10% vacancy) that we set aside in an account and then share the repairs and other costs moving forward. Whatever is left is split 50/50. When we cash out of the property - around 5-10 years, the profit is 50/50. Is this similar to how you are doing it?

[Daniel H.]

@Alex M.

If your finance partner is on the title and mortgage, when it comes time to sell the property, how will they indicate to the IRS that a portion of the profit was paid to you, and therefore they shouldn't be taxed on that amount?

[Justin R.]

Alex M. The partnership files an information return (form 1065) with the IRS each year. This shows income, expenses, deductions, etc, just like an individual's regular 1040 does. However, it also includes a schedule (a "Schedule K") that tells the IRS how the profit/loss of the partnership is being allocated to the partners. When the asset is sold, the partnership reports any net profits from the sale on that Schedule as a capital gain. Let's say that shows a $20k capital gain from the sale. For tax purposes, it doesn't matter who was on title - that $20k gets allocated on the tax return by the partnership to the partners based on each partner's distribution percentage (the IRS knows the exact amount because the partnership reports it on the Schedule K-1).

[Justin R.]

Sorry @Alex M. ... my previous reply should have been directed to @Daniel H.

PS: @Account Closed Post response formatting from the BP mobile app on iOS could use some improvement - looks like paragraphs and new lines are ignored.  :(

[Daniel H.]

Thanks @Justin R.

Does the partnership need to file any paperwork such as applying for an EIN prior to filing a form 1065?

[Justin R.]

@Daniel H. Yes, the partnership needs an EIN.  It's simple and painless - you can get one online.

The OP said he wasn't planning to form a separate entity (like an LLC), so the paperwork/process stuff is more straight forward.

Note that your question asked about the scenario where only one partner holds title.  I'm sure other people / partnerships do this, but I don't have experience with it.  I don't know if there are other legal implications of holding title singularly vs. holding it in a form that indicates the partnership has the interest, though I would expect there is.

[Alex M.]

@Justin R. and @Daniel H. thanks for asking these questions and your replies. This is helpful information as I am just getting going with this and trying to understand the best way to structure the partnership, as well as to understand the tax implications.