How to Structure a Partnership

Question

Hello,

I recently just put some properties under contract with an investor. This is both of our first deal, so we are unsure as to how to structure the partnership. He supplied the funds to do a cash offer, so the properties are under his name. I am supplying the rehab costs. Thoughts on what we should do to ensure we both get tax benefits and can keep track of who has spent what? Is it just easiest to form an LLC, and a joint bank account and go from there?

Scott Smith · Answer

Hey James,

You always want to define roles and get an agreement of this sort in writing, and the LLC provides that through the Operating Agreement. On top of that it also creates liability protection for all parties involved,  so if there is any legal issues involved with any partners or the investment it can't "splash" into the other partners or the investment.

The most common entity for this type of transaction is the Joint Venture LLC. On your first run I would highly recommend having an experienced attorney draft it for you, as they can guide the process and help you outline what actions should take place in different circumstances you may run into. (Examples may be when one partner decides they want to sell and the other partner(s) don't, etc.)

If you don't have it in writing these issues can be a huge problem, but if you bite the bullet early you save yourself a tremendous amount of work down the road. Plus you are protecting yourself, which is always smart.

Gary Barella · Answer

@James Teutschmann

Also don’t even use attorneys when you’re buying or selling if your state will allow it, more waste of time and money… LOL

Gary Barella · Answer

@James Teutschmann

Awesome brother I just want to tell you though don’t go in there telling them exactly what you’re doing because they can easily be like oh no we aren’t lawyers you can’t do that here… You just Gotta be like “hey we have accounts here we need this notarized.” our guy doesn’t even read it or care he just sees the signatures and looks at her licenses.

James Teutschmann · Answer

Thanks for your comments. We are forming a joint venture. Since we are friends, we are writing the terms and having them notarized at our bank. Thanks @Gary Barella!

Art P. · Answer

@James Teutschmann

As @Taylor L. suggests, formulate a partnership agreement ASAP and have it looked over by an attorney. This agreement will spell out your share of equity based on terms you set. For example, you contribute $10k, and your partner contributes $90k. You can agree to split profit 50/50 even though equity contribution is not equal. When liquidating the deal, you will equally split the profits/losses and distribute initial equity invested, $10k back to you, and $90k back to the partner.

From a tax standpoint, regardless of whether this is a partnership or LLC running transactions through a business bank account is highly suggested. A partnership will be a pass-through entity which will report all share of profits to your individual 1040's regardless of whether you distributed the money or not.

Similar to a partnership, an LLC is taxed the same way, however, you are able to get limited liability protection on the venture. Remember to run the partnership under an LLC as a separate legal entity and not as an extension of your personal accounts.

Either you and/or your partner will be subject to self-employment taxes. The general exception to the rule is individuals who have merely invested money but don't provide services or make management decisions for the LLC may be exempt from paying self-employment taxes on their share of profits.

Taylor L. · Answer

No way. You should define all of your roles and responsibilities now (or before, preferably), write them down, sign, and talk with an attorney. This looks like a Joint Venture type of scenario. You need a proper written agreement.