Every so often, I get asked questions regarding forming real estate partnerships. The problem is they want me to tell a secret mantra when there actually is no mantra.
The best way to find the perfect structure for a real estate partnership is trying out different formations. For some, forming an LLC and owning everything on 50-50 basis might work. For others, this might not be the ideal situation. So there’s no one-size-fits-all situation.
However, there are some basic things that will help you approach the best way to structure a real estate partnership.
Everyone has their own entity
This is a simple fix that can help you in adding value to your partnership. What I am suggesting is – instead of each partner investing through their own name, they can invest through their entity.
Let me explain you. For example, let’s say you and your partner both want to utilize your own entity, say Lex-Corp and Luthor-Corp. In this case, you shouldn’t jointly own an LLC or as a matter of fact, any type of entity through your own names.
While an LLC can be taxed as either your Lex-Corp or your partner’s Luthor-Corp, not both. It has to either be the Lex-Corp or the Luthor Corp, there’s no common ground in between. So in a situation where you and your partner both want or need to utilize different entity structures for maximizing tax efficiency, either you or your partner will lose.
Even in a real estate partnership, all partners should look for ways to maximize the benefits favoring themselves. So, the workaround here is for you to create your own entity. Then both of you can have your personal entity taxed as a partnership, Lex-Corp, or Luthor-Corp.
This way, regardless of what you choose as a tax structure, your partner is not bound to choose the same. He can choose a complete different one via his own personal entity.
Note that the scenario that I just presented is best suited for a partnership with 50-50 share. If your partnership has any other ratio, things might be a bit different.
For flexibility, a shared LLC is the best call
In most cases, a simple LLC is the best structure to choose for a partnership. This LLC in real estate partnerships is popular because of two main reasons.
- You get flexibility in divvying up your profits among the owners.
- The administrative burden on the entity management remains at a minimum.
This shared LLC will be the parent or controlling company for the individual entities. Whether you open a whole new entry per flip or per rental property, your shared LLC will “invest” in the entity which owns the property.
Effect of entity selection on the profit distribution
Between all of the entities, an LLC is your best option because other entities aren’t as flexible as a shared LLC. In an LLC, the percentage share of capital, profit, debt, or loss can be different. For example, say you and your partner invested the same amount of money in the real estate venture. But you are the one who does the intricate jobs like finding deals, researching markets, renovating a place, etc. So obviously, you deserve the greater portion of the profit. This is possible with a LLC. That’s why I think LLC is more flexible than any other entity. Always consult an attorney before starting a corporation.
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