Partnership Structure and Taxes

9 Replies

I've searched the forums and I can't find direct answers to my questions. I am looking at starting a partnership(s) in order to invest in buy & hold rental properties, where I bring the deal and management and the partner brings the money. Looking for some insight from those who have done it before, maybe @Brandon Turner or @ Amanda Han can weigh in.

1. With the pass through structure of a LP or LLC, does the entity have to own the mortgage in order to pass through the tax savings to the members? What if my partner is named on the mortgage, and I am only on title...can I still get the tax benifits?

2. The banks I have contacted all say they require everyone who is on title to be on the loan, but in listening to @brandon turner it seems that others have structured it so they are not named on the mortgage. How is this done?

3. Obtaining financing in the name of an LLC or LP vs. personally holding the mortgage?

Medium peak7 logoSam McPeek, Peak 7 Properties, LLC | [email protected] | 509.308.6944

@Sam McPeek  you have two choices in how to structure the capital: equity or debt. 

If you structure this as debt, your money partner loans you the money and gets paid interest.  The loan can either be secured by the property or unsecured. Based on the way you framed your question I don't sense that a debt structure is what you are looking to do.  

If you structure it as equity, your money partner becomes an owner. He or she would either own the real estate directly (such as being on title alone or with you) or would own a interest in an LLC or LP that would own the real estate.

I'm not an attorney, so this is not legal advice. I'm also not a CPA so this isn't tax advice either. Please consult with the proper professionals and get specific advice on the best structure for your situation. That said, here is what I would do.

I wouldn't recommend owning the property as individuals. When two or more people own real estate together it doesn't make sense to own it individually because things can happen to one partner that can effect the other partners interest in the property. Entities are designed to mitigate that risk.

If I were you, I would buy the house in an LLC or LP with your investor as the limited partner and you as the general partner, or if you go with an LLC you could both be members of a member-managed LLC or your investor could be a member and you the manager of a manager-managed LLC.

The entity should hold title to the real estate and should be the borrower on the loan. Either you or your money partner, and possibly both of you, will likely be required to sign personal guarantees on the loan. The LLC operating agreement or LP agreement can dictate who gets the depreciation. I typically allocate the depreciation to the investor.

As to question 2, everyone on title has to be on the loan.  If the property is owned by an entity as I outlined above, only the entity will be on the loan.  But as I mentioned you and perhaps your partner will probably have to sign personal guarantees.

Medium praxis capital logo cmyk stacked 900pxBrian Burke, Praxis Capital, Inc. | [email protected] | http://www.PraxCap.com | Podcast Guest on Show #152

Thanks @Brian Burke ! That's what I was missing, the LLC on title with a personal guarantee on the loan. Why do you allocate the depreciation to the investor? Do you figure that into their return?

 I just recently listened to Podcast 076 featuring you, and that was great stuff! That's definetly one that I will listen to again.

Medium peak7 logoSam McPeek, Peak 7 Properties, LLC | [email protected] | 509.308.6944

Thanks for the feedback on the podcast, @Sam McPeek  , I'm glad you enjoyed it!

I allocate the depreciation to the investor because accredited investors tend to have plenty of income and investments that produce income but don't add to their tax burden are more attractive to them.  Attracting capital fuels my growth.

Depreciation can offset some and perhaps all of the income, and on larger deals there are things we can do to create depreciation far in excess of the income so that the investors can even offset some of their other income in some circumstances.

Medium praxis capital logo cmyk stacked 900pxBrian Burke, Praxis Capital, Inc. | [email protected] | http://www.PraxCap.com | Podcast Guest on Show #152

Originally posted by @Brian Burke :

Thanks for the feedback on the podcast, @Sam McPeek  , I'm glad you enjoyed it!

I allocate the depreciation to the investor because accredited investors tend to have plenty of income and investments that produce income but don't add to their tax burden are more attractive to them.  Attracting capital fuels my growth.

Depreciation can offset some and perhaps all of the income, and on larger deals there are things we can do to create depreciation far in excess of the income so that the investors can even offset some of their other income in some circumstances.

 Brian - thanks for your post. If you allocate all of the property's depreciation to the Investor, then where does that leave you? Any money earned from your % ownership of the money means you have to pay higher taxes on it? Rental income and then also with any portion of the gain when you sell? 

Originally posted by @Michael Khakshouri :
Originally posted by @Brian Burke:

 Brian - thanks for your post. If you allocate all of the property's depreciation to the Investor, then where does that leave you? Any money earned from your % ownership of the money means you have to pay higher taxes on it? Rental income and then also with any portion of the gain when you sell? 

I wouldn't characterize it as paying higher taxes on it...just paying taxes on it.  So yes, anything I earn is taxable income.  It will be ordinary income from rents during the hold period and capital gain upon sale.  I would have no depreciation recapture upon the sale either, since I didn't take depreciation during the hold period.

Tax advisors can chime in here and correct me, but I don't think you can claim the depreciation anyway unless you have money in the deal.  Something about taking losses over your basis (and if you have no money in the deal your basis is zero).  There are exceptions if you personally guarantee the loan but you'd have to get professional advice because taxes aren't my thing.  Take what I say about taxes with a grain of salt.

As to why I allocate the depreciation to the investors, my philosophy is that the investors are bringing the money to the table so they deserve the depreciation.  I'm not, so I don't.  They are investing.  I'm working.  They get tax breaks like investors.  I don't, like a worker.  Just my personal philosophy, other folks take a different stance and that's fine by me.  :) 

Medium praxis capital logo cmyk stacked 900pxBrian Burke, Praxis Capital, Inc. | [email protected] | http://www.PraxCap.com | Podcast Guest on Show #152

You need a partnership tax lawyer for this one. God luck.
Originally posted by @Brian Burke :
I wouldn't characterize it as paying higher taxes on it...just paying taxes on it.  So yes, anything I earn is taxable income.  It will be ordinary income from rents during the hold period and capital gain upon sale.  I would have no depreciation recapture upon the sale either, since I didn't take depreciation during the hold period.

Tax advisors can chime in here and correct me, but I don't think you can claim the depreciation anyway unless you have money in the deal.  Something about taking losses over your basis (and if you have no money in the deal your basis is zero).  There are exceptions if you personally guarantee the loan but you'd have to get professional advice because taxes aren't my thing.  Take what I say about taxes with a grain of salt.

As to why I allocate the depreciation to the investors, my philosophy is that the investors are bringing the money to the table so they deserve the depreciation.  I'm not, so I don't.  They are investing.  I'm working.  They get tax breaks like investors.  I don't, like a worker.  Just my personal philosophy, other folks take a different stance and that's fine by me.  :) 

Brian - I cannot appreciate enough the time you spend in providing the details for other investors!  Every post and article you publish has extraordinary amount of help within.  The topic of structuring partnerships and syndication is so fascinating that "someone" should write a BP post on it.  Or a book....

Not sure if you entertain meeting BP folks but I would love to come buy you a lunch or beer (or both :) some day.  I am in San Jose area so couple of hours from you.  I am sure the drive will be worth it.  

Free eBook from BiggerPockets!

Ultimate Beginner's Guide Book Cover

Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks and techniques delivered straight to your inbox twice weekly!

  • Actionable advice for getting started,
  • Discover the 10 Most Lucrative Real Estate Niches,
  • Learn how to get started with or without money,
  • Explore Real-Life Strategies for Building Wealth,
  • And a LOT more.

Lock We hate spam just as much as you