Partnership Agreement or LLC / Partnership Exit Strategy

[Travis Pirtle]

Hi all,

I purchased a property with a good friend 7 years ago. We each put down 50% of the down payment and split the cost for new paint, appliances, and small repairs needed prior to listing the unit for rent. We agreed up front to a buy and hold strategy with no profits drawn until we decide to either sell or buy a 2nd property.

We self-manage and I have handled all the bookkeeping and day-to-day operations (of which there are few).

We have been fortunate to do very well with this property in terms of cash flow ($550/month), appreciation (63k to about 110k), and tenant turnover (none!)

Unfortunately, we were sloppy in our setup of this partnership. The loan is entirely in my name and we have no partnership agreement or operating agreement of any sort on paper. I'm sure you can all see how this has the potential to go south.

We are seeking advice on the best way to protect both of us. I know an LLC would give us 50-50 ownership, but the due on sale clause worries me. I have been told by an attorney it's extremely unlikely for an account that is in good standing, but I am looking for more opinions there. Could we get by with a simple Partnership Agreement?

We also know that someday we will want to sell. Assuming we don't do a 10-31 exchange, how do I go about (legally) transferring a large sum of money to him without being hit with the Gift Tax? An LLC would solve this problem, but would a Partnership Agreement? I am entirely confused on how to go about this part of it.

This property is in Chicago, IL.

Thanks in advance! 

[Kerry Noble Jr]

I agree with your attorney on the Due on sale part

however what about a Trust?? and having both of you guys in the trust....??

[John Warren]

@Travis Pirtle you should connect with a good local attorney ASAP. I can send you one if you need one. This is a simple question for an attorney, and this won't cost a fortune to get done. This is definitely not something to mess around with in my opinion. 

[Jonathan Klemm]

@Travis Pirtle  - Definitely a chicago attorney question for someone like @Bob Floss II.  But my thought which doesn't hold water in this case is that you need to establish an entity or partnership agreement and simply quitclaim the property into the new entity that you guys each own 50/50.  I honestly wouldn't worry about the due on sale clause.  Another option might be to refinance into the new entity instead of quitclaim which would potentially address the due on sale clause.

[Crystal Smith]

Quote from @Travis Pirtle:

Hi all,

I purchased a property with a good friend 7 years ago. We each put down 50% of the down payment and split the cost for new paint, appliances, and small repairs needed prior to listing the unit for rent. We agreed up front to a buy and hold strategy with no profits drawn until we decide to either sell or buy a 2nd property.

We self-manage and I have handled all the bookkeeping and day-to-day operations (of which there are few).

We have been fortunate to do very well with this property in terms of cash flow ($550/month), appreciation (63k to about 110k), and tenant turnover (none!)

Unfortunately, we were sloppy in our setup of this partnership. The loan is entirely in my name and we have no partnership agreement or operating agreement of any sort on paper. I'm sure you can all see how this has the potential to go south.

We are seeking advice on the best way to protect both of us. I know an LLC would give us 50-50 ownership, but the due on sale clause worries me. I have been told by an attorney it's extremely unlikely for an account that is in good standing, but I am looking for more opinions there. Could we get by with a simple Partnership Agreement?

We also know that someday we will want to sell. Assuming we don't do a 10-31 exchange, how do I go about (legally) transferring a large sum of money to him without being hit with the Gift Tax? An LLC would solve this problem, but would a Partnership Agreement? I am entirely confused on how to go about this part of it.

This property is in Chicago, IL.

Thanks in advance! 

Something to consider that we have used in the past. Even if you create an LLC after the fact and state that each party has 50% interest unless there's a filing with Cook County, your partner's interest are not really protected. In situations like this we have filed & recorded a Notice of Interest with Cook County Recorder.  We've done this when loaning $ on deals when an HML would not allow a 2nd position to be recorded when closing on a deal.  The Notice of Interest was recorded weeks after closing & when the properties were eventually sold, the notice was found by the title company & had to be settled at closing.  We would file the notice in the name of our LLC & have never had any problems.

[Andy Nathan]

@Travis Pirtle have you spoken to a portfolio lender about possibly refinancing into a company? If you had a refi that was close to ready, it would be less of a concern over due on sale. Not sure but we're rates higher than today? I know they are going up, but maybe it could be to your benefit.

[Bob Floss II]

@Travis Pirtle There are a lot of complicated issues here that would need to be discussed over a consultation. One easy thing I can address is the possibility of a 1031 exchange down the road. If the property is in your name, when you do a 1031 exchange, the intermediary will require the way you held title in the property you sold to be the same as the property you purchase. You would need to be the named party purchasing a new property and go on the deed again. I recommend doing your planning now so it doesn't limit your 1031 later.