Now that prices are off sharply from their peak levels of a few years ago, you may want to invest in real estate. If so, you are looking for a promising property at the right price. Assuming you find such an opportunity, youll have to make still another crucial decision: how to hold your property.
The simplest option is to hold the property in your own name. Youll have absolute control and flexibility. You can make the decisions on capital improvements, tenant selection, and so on; you can sell the property or refinance it.
Youll face some disadvantages with this form of ownership, however. Depending on the amount of capital youre willing to invest, you might be limited in what you can buy. Youll also have to be sure that youre adequately insured against any liability resulting from someone being injured on your property.
Married couples especially might want to hold investment property as joint tenants with the right of survivorship. That way, when one owner dies, the surviving owner inherits automatically. The real estate wont go through probate, which can be expensive and time consuming.
The downside? When property is held as joint tenants with right of survivorship, no other heirs can inherit it. If you have remarried and hold property in this manner with your spouse, for example, you cant leave all or part of this investment to children from a previous marriage.
As another approach to real estate investing, you might pool your capital with others to form a general partnership.
Example 1: Tom Adams, Richard Baker, and Harriet Carter form a partnership to buy investment property. When they find something for sale that they all like, each will contribute one-third of the capital.
With this method, the partners will have access to more expensive real estate (compared to what they could have bought as individuals), and they will have extra hands to help oversee their investment. Any investment losses can be passed through to each partner.
Suppose that the partnership of Tom, Richard, and Harriet buys an office building. In 2011, the property posts a $30,000 loss for tax purposes. As per their partnership agreement, each of the co-owners will report a $10,000 loss on his or her tax return for the year. That loss may be deducted now or in the future, depending on the taxpayers adjusted gross income and the partners adjusted basis in the venture.
As with anything, general partnerships are not without drawbacks. Conflicts may arise if the individual owners disagree among themselves on issues relating to the real estate. Also, each partner is personally liable for debts the partnership incurs. Even with insurance, the investors personal assets might be at risk.
Some limitations to the general partnership might be more appealing. A limited partnership is a specialized form of partnership, with two types of partners.
Limited partners are usually investors with no say in the management of partnership assets. They are liable only for the capital they contribute and any notes they sign. Often, any real estate losses are allocated largely to the limited partners for tax purposes.
One or more general partners runs the business. In a real estate limited partnership, the general partner is responsible for managing the property or delegating that responsibility. The general partner bears liability for all of the partnerships obligations.
Limited liability companies
A limited liability company (LLC) might offer the best features of all the other structures. As an LLC investor (or member), youll benefit from partnership taxation. That is, any losses from the real estate are passed through to each members tax return. In addition, LLC members enjoy the same type of limited liability that corporate shareholders have, so their other personal assets are not at risk.
In these litigious times, you should not downplay the threat of personal liability from real estate investments. By recognizing the danger, you may be able to limit your exposure.
Example 2: Jane Clark invests in several rental properties. She has no co-owners. To minimize her paperwork, Jane could create a single-member (one owner) LLC to hold all those properties. Instead, Jane creates a separate single-member LLC for each property. Therefore, if a tenant is severely injured at one of Janes properties and sues for damages, the risk can be confined to that one property rather than affect all of the investment real estate Jane owns.
If you have any questions regarding the above discussed topic or any other tax matter, please feel free to give me a call at (562) 698-9891.