Limited Partnerships?

Question

Hello everyone.  Im a fairly new player in the RE market.

My partner/friend and I have been living in our first property (a condo) for two years now and are now about to buy our second.

Up to this point, the first prop is owned by my partner.  However, we want to form a limited partnership to buy the second as well as transfer the first into.

I have seen discussions about LLC's and Corps, but nothing on LP's.  I am very familiar with LLC's and Corps (Ive started a few before) but I've never formed an LP.  Anything different?

My question is are there any suggestions or important drawbacks to forming an LP with two equal partners?

Thanks in advance!

Jose

Ryan Webber · Answer

Yes, entity protection will allow you to separate your personal assets and other business assets from inter-liability.  Some corporate structures have different tax advantages, and the professional image of an entity always helps, too.  As you develop your business down the road you can also get non-recourse loans in which you are not personally liable for the debts of the company.  Estate planning also plays into it since entities do not have to go through probate.

Again, I would highly recommend that you consult with a qualified attorney and accountant on these matters.

Ryan Webber · Answer

Again, I would say that it comes down to a personal decision.  You PROBABLY won't run into any trouble with your first deals.  You may never run into trouble.  You may get sued on your first house.  It will come down to a personal decision on your part.  If you are looking at this as a long term opportunity and you have the capital to do it, then I would probably just set one up now.

I have done a couple hundred transactions in the last four years and have not been sued, yet.  I always treat it like a business and treat people fairly and always within the parameters of the law, but I feel a lot better knowing that I am protected if it ever comes to that.

Bill Exeter · Answer

You need to consider your exit strategy as well.  I have seen many GPs, LPs, multiple member LLCs, etc., get to the exit strategy point and all want to go their separate ways via a 1031 exchange and these entities create exit strategy problems.  In many case, it might be easier to have each of you establish your own single member limited liability company (SMLLC).  The SMLLC is a disregarded entity for income tax purposes, but still provides you with liability protection.  The properties can then be acquired by each of the SMLLC's as tenants-in-common and be operated under a tenants-in-common agreement.  This gives both parties the complete freedom to do what ever they want before, during and after with out getting "stuck" with each other.

N/A N/A · Answer

That I will.  Thanks Ryan.  I hope this post has helped others as well.  You rock!  :rock:

N/A N/A · Answer

Thanks again Ryan.  So the main purpose of the LLC is a form of lawsuit protection.  Is there any other reason or benefits?

N/A N/A · Answer

Thanks for the info Ryan, I too have a question.

At what point would/should you open a LLC.  You stated many choose to have this done in the beginning some don't.  I "plan" on buying under 5 houses this next year (rehabs/flips) then gradually grow the following years.  This will be done on a partime basis ... should I go ahead and form the LLC now, later, after first flip, etc.

Thanks again for your wisdom!

Jim

Ryan Webber · Answer

I would have to say it comes down to a personal decision on your part.  You probably aren't going to get sued on your first couple deals, but the key word is probably.  Some people like to get their entity structuring done in the beginning.  Some investors don't even use entities but utilize umbrella liability policies.  And some investors like to get moving first and then down the road shift into entities.  I went with the last strategy.  I had been investing for about a year and had done a dozen or so deals before I started putting my properties into an entity.

You might want to look into just doing an LLC versus an LP.  It provides the same protection and is simpler to setup and run, and if you are planning on doing let's say 10 houses a year then it could be a better fit for you.  A good attorney and accountant are the best ones to bounce these ideas off of.

N/A N/A · Answer

Ryan,

I guess my strategy is to simply evaluate a property and see if will be a good flip, rehab, or rental.  I will flip or rehab if the numbers work.  If I can buy a house in an area with potential then I might consider renting it for some time and sell it later on.

My situation now is that I am putting in a contrac for our second property.  This property is a foreclosure, needs cosmetic work and some foundation repair.  Normally, I would stay away from foundation issues, but my partner has a background and degree in architecture and she visually inspected the property and found nothing serious.

My agent told me that there are documented issues with the foundation, the paperwork recommends adding 10 piers to the slab foundation.  I got quoted about $250 a pier.

Using Zillow, the houses in the area are valuing $24-53K more than this property is selling for.  It is close to a major university, schools, and shopping.

Going back to my question about LP's, I am just wondering if it is time to start one now that my partner and I are about to buy our second prop.

Thanks,

Jose

Ryan Webber · Answer

An LP has a little more complication factor to it than the LLC.  An LP will need to have a general partner (GP) that will be liable for all the decisions made on behalf of the limited partners.  Normally a good attorney will advise you to use an LLC as the GP, so you end up setting up both.

Now there are some other factors to think about.  Mainly, your state's filing fees and entity/franchise taxes on different entities.  Up until next year an LP in Texas did not have to pay any state franchise taxes, which made using an LP for a higher grossing company very advantageous over other entities.  The LP in Texas, however, had twice the fees to file than an LLC, and you had to file an LLC anyway for the GP.

Also, my understanding from my accountant is that dealer status for an LP does not affect taxes paid.  Dealer status normally requires you to pay SS and income taxes on all your profits just as if they are ordinary income.  You can be tagged as a dealer if you are flipping houses as part of your regular business.

I forgot exactly why the LP is exempt but that was one of the major factors that led me to set up my newest company as an LP, even though next year I would have to start paying franchise taxes on it in Texas.

I would highly recommend discussing these subjects with a qualified accountant and lawyer in your state.  Statutory and case law in each state make a difference in how some aspects of each entity work and how they are taxed within that state.

Ryan Webber · Answer

Jose, I just noticed you're in Texas.  I might be able to illuminate the advantages of different entities moreso if you can tell me about what your plans are in real estate.  Have you figured out if you are looking to hold rentals, fix up and resell, or do some other kind of creative investing?