Any CPAs/attorneys or other experienced investors who have out there who would recommend how I should form a partnership for a one-time real estate deal?
A friend and I would like to do a real estate deal together in California (he's in CA and I'm in UT). I think it would be wise to draft a partnership agreement just to have expectations written up in advance. We're open to doing a flip or a BRRRR and holding it short (flip) or 2-5 years or longer, depending on what we run into. The plan is for me to provide the credit/financing/mortgage, and my partner is providing the down payment.
What advantage would there be to creating an LLC or an S Corp? I'm pretty sure both of those entities can own the property. Can we buy it as a simple partnership, too (put both of our names on the mortgage)? My main reason for thinking to create an LLC would be for liability purposes to protect against tenants. But now I'm thinking about it, I wonder if it would help protect against me owing all the mortgage if the deal goes bad and my partner leaves me dry. The chances of that are extremely low, but I think it's good to be safe.
I'm familiar with how S Corps can have tax advantages by paying yourself a lower income of the net profit, but since our annualized income from the property will be relatively low, I'm not concerned about that as much (unless it saves $ if we decide to flip the property?).
You're definitely wise to have a written agreement before you go too far down the road of working with a partner. Some food for thought is that general partnerships have unlimited liability, and limited partnerships need a general partner who has unlimited liability. If you're looking to have a fairly simple structure with limited liability, you may want to look into the LLC option. Also, you may want to look into the tax consequences of a sale/distribution of the property differences in an LLC versus S-corp.
*this post does not create an attorney-client or CPA-client relationship. The information contained in this post is not to be relied upon. Readers are advised to seek professional advice.
"flip or a BRRRR"
"Holding it Short or 2-5 years or longer"
Reading your post tells me that you have no plan and you will try anything.
There are ways for you to buy the property as tenants in common and you would both be on the deed/mortgage.
@Katie Lepore Thanks! So if we do a general partnership, we each have unlimited liability on the property. My mortgage broker said it would be easier to purchase the property like this vs an LLC. Why I'm thinking about the LLC is for the liability purposes. My mortgage broker said we could purchase the property as a general partnership to make the transaction smoother and transfer it to an LLC. Does this sound correct?
@Basit Siddiqi Thanks for the TIC comment. I'll have to look into that as an option. As far as our plan, since it's our first deal together, we hashed out all the possibilities and made sure we were okay with any of the outcomes. We have multiple exit strategies that we have decided would be satisfactory. It depends on how good the deal is that we find. If it ends up cash flowing really well, we will end up holding it longer. If not, it may turn into a flip. Our hold time will depend on how long my partner stays local, since he's our boots on the ground property manager.
Exploring legal liability and the best setup for it is Step 2.
Exploring tax benefits is Step 3 (and is totally pointless when your business plan is this unclear).
You missed Step 1: figure out what you're trying to accomplish together and why you want to do it together. I can think of 3 reasons to do a business deal together:
1. You're close friends or relatives, and you think that doing business together is more fun, with the benefit of peer support, brainstorming, one covering for the other etc. This is an awful reason to do business together, based on my 25 years of evidence from hundreds of clients. And based on basic common sense, too.
2. You could do deals separately, but you find that combining your resources (money, skills, connections, time etc.) will allow you to achieve bigger, better and faster results. This is an excellent reason to do business together, but it only applies to people with prior history of separate success. And even then it comes with great risks, by the way.
1 success + 1 success = 3+ successes
1 newbie + 1 newbie = 0 success
3. You're unable to do a deal separately, because one of you has one necessary component (usually money or credit), and the other one has the other component (usually, time or skills). This is very common and very troublesome.
This is why. Since your buddy wants you to provide financing, it indicates that he has little to no resources and poor to no credit. When things go wrong (and they do so, way more often than you want to believe) - YOU will be holding the bag, because it is YOUR money and YOUR obligation to repay the lender.
Your friend does not have enough skin in the game and can walk away relatively unharmed. You can't. In fact, as a co-owner of the property, he can tie your hands and hold you hostage until you satisfy his demands. How? By refusing to sign off on paperwork to sell or refinance the property, for example. Yes, I have plenty of real life stories.
You say friends don't do this to friends? If I had a nickel for every friendship I personally know ruined by this assumption, I would have had enough for a down payment on your property. And if I also had a nickel for every partnership I saw formed with an expectation of things never going wrong, I would have enough to buy your property free and clear.
Even when things go right, partnership is fraught with risks. Imagine everything went well, and now you have a profitable rental owned 50/50. You want to sell it and cash out, and your partner wants to keep it. And you both dug in. Yes, I have seen this scenario killing old and solid friendships.
What do I suggest? I suggest you ditch the idea of partnership in all its forms and buy this property by yourself if you even have a property in mind. Need his cash for down payment? Make him a lender, not a co-owner (although this may not work for lending). Need his connections to find a deal? Pay him commission. You get the idea.
And if neither of you has any real plan as to what you're going to do yet, then start with the plan.
@Kyle Wilson all great advice. Just as important as starting your partnership is thinking how it will end too. Meaning that in an llc you need to spell out the terms on how it can dissolve if one party wants out, one party dies, divorces, etc.
If you are doing one project only to see how it goes, do not overthink this. It appears both of you will have skin in the game - you on the credit side and your putative partner in providing the down payment. Accordingly, it makes sense for you to both be on the title so you should take the property as tenants in common (as opposed to joint tenants). Google these terms to see what they mean. Your partner should also become a co-obligor on the promissory note that you will sign to get credit. If for some reason that becomes a problem, your partner should provide you with a note requiring him/her to be responsible for 50% of the mortgage.
Creating an LLC is expensive in California and will not provide any bulletproof solution to potential liability. I have owned/bought 15+ properties in California over the years and have had no need for one until recently (for an issue having nothing to do with your plan). Buy a landlord/fire insurance policy and a personal umbrella policy - oyur insurance broker can advise you on specifics.
You of course should have a written partnership agreement that spells out terms, responsibilities, and what happens at the exit. You can find suitable exemplars on the web. For a couple of hundred bucks you should have an attorney review your agreement.