Selecting the Entity for a Real Estate Purchase – Partnerships

In the first part of our series concerning entity selection for owning real estate, we addressed sole proprietorships and tenants in common. Here we examine the business and tax law considerations concerning partnerships.

General Partnerships

A general partnership is essentially an association of two or more people to carry on a business as co-owners. No written agreement is necessary to have a general partnership. One advantage of the general partnership form of ownership is tax benefits. No taxable event happens at the partnership level. In other words, no double taxation occurs in a general partnership. The usual test the IRS uses to determine if a partnership exists is whether the partners share profits and losses, jointly own the capital and assets, and jointly control and manage the business.

General Partnership Advantages and Disadvantages

Other advantages of general partnerships include the following:

  • Each partner can participate in the management of a general partnership.
  • Continuity of the general partnership can be established.
  • The ownership interest in a general partnership is treated as personalty rather than realty.

The disadvantages of owning property in a general partnership include:

  • There is unlimited liability for general partnership partners.
  • The decisions of one partner can bind the other partners.
  • The life of a general partnership is not perpetual in duration.
  • Each partner’s interest may not be easily marketable to third-party purchasers.

The structuring of a 1031 exchange by a subsection of the partners is one of the most common questions asked by taxpayers and addressed in the article, “1031 Drop and Swap out of a Partnership or LLC.”

Limited Partnerships

A limited partnership is an association of two or more people in which the entity has one or more general partners and one or more limited partners. The limited partnership is usually established by filing a Certificate of Limited Partnership with the clerk of the county in which the partnership will be doing business or with the applicable Secretary of State’s office or similar agency.

Limited Partnership Advantages and Disadvantages

The major advantages of using a limited partnership to own real estate include

  • A limited partnership allows a passive investor,not active in the management decisions of the partnership, to participate in the investment.
  • The liability of each partner is limited to the amount of capital that the investor has agreed to put “at-risk.”
  • There is continuity of a limited partnership in the event of death, bankruptcy, or withdrawal of one of its partners.

The disadvantages of owning property in a general partnership include:

  • In order for their liability to be limited, the limited partners cannot engage in the management of the partnership or its property.
  • The general partner is responsible for making management decisions concerning the limited partnership.
  • A limited partnership is difficult to market to third-party purchasers.
  • The limited partners must rely on the ability and expertise of the general partner or else they risk losing their limited liability.

Summary

In the first of this series on selecting a real estate entity, we looked at sole proprietorships and tenant in common entities; in this installment we examined the advantages and disadvantages of two types of partnerships. In part three, we discuss corporations and the corporate form of ownership.