Real estate trusts, partnerships or LLCs?
April 28, 2011 12:54 PM   Subscribe

My father and I are interested in buying and splitting an investment property 50-50. What are the sort of legal arrangements we should be looking into to lower tax burdens and maximize buying power? LLC? Trusts? Who should we be talking to about this?

We both have quite a bit of assets, but my income is lower (and shorter history) so I pretty much would need him to co-sign if I were to try and do this myself. We are looking at multi-unit properties with potentially positive cash flows after the down payment. It is possible I would be living in one of the units and paying rent. Also, we are in California.

We have no fears about one person not being able to pay down the road. We are just interested in different ways to set this up that might benefit us with lower taxes and possibly would increase our buying power if we wanted to get more properties after the first one (not an issue currently, but want to make educated decisions).

Obviously We should be talking to someone professional about this. But would like to understand the basic options first. And what is that professional's title exactly?
posted by notnathan to Law & Government (7 answers total) 2 users marked this as a favorite
 
Who should we be talking to about this?

A lawyer with real property/real estate transaction experience to structure the investment entity and perhaps a financial advisor if you're looking to make this part of your investment strategy and not a one-off.
posted by Inspector.Gadget at 12:57 PM on April 28, 2011


You're going to want to talk to a lawyer and or an accountant. The former will be able to help you with the legal ramifications like ownership and liability, and the latter with the tax and other financial implications.

But do get professional help here. Money well spent.
posted by valkyryn at 12:57 PM on April 28, 2011


One piece of advise I would give you - plan for the END now!
Right now, start figuring out ways that you can dissolve the partnership. I have been in partnerships before - some were great, some terrible.

People's lives change - and one of you might want to end the investment before the other. Decide now on how that can happen.

Also, if you can, go see a lawyer.
posted by Flood at 1:29 PM on April 28, 2011


We have no fears about one person not being able to pay down the road.

You should definitely have fears about this.

If not fears, at least concerns, and a plan in place, like Flood said, to dissolve or restructure the partnership if one of you cannot or will not participate any more.
posted by Aizkolari at 1:35 PM on April 28, 2011


We have no fears about one person not being able to pay down the road.

You should. Neither of you should co-sign unless you are 100% okay with paying the entire amount yourself without the help of the other, because that is what you are signing up for. Most people who co-sign trust each other the same way you and your father trust each other, and co-singing doesn't seem like a big deal up until the point where one person stops making payments, but it still ends up getting a lot of people into a lot of financial trouble.

We both have quite a bit of assets, but my income is lower (and shorter history) so I pretty much would need him to co-sign if I were to try and do this myself.

If you're not paying cash then you are not going to be able to buy this through a LLC. A bank is not going to lend money to a company that has no assets and can fold at any time, they are only going to loan money to both of you personally, based on your personal assets and income. Once you buy the property you can probably use some financial tricks to transfer it to the LLC, but the debt is still going to be in your names.

We are just interested in different ways to set this up that might benefit us with lower taxes and possibly would increase our buying power if we wanted to get more properties after the first one

For taxes talk to an accountant. An investment property doesn't have the same kind of tax benefits as a primary residence so relative to normal home ownership you are probably not going to get as much of a tax break.

For buying power, first of all as I said above you are going to have to apply for a personal mortgage like everyone else so your buying power is mainly limited to how much a bank will be willing to loan to you based on your personal financial situation. But also note what has happened to pretty much all of the real estate investors that tried to maximize their buying power, they are all out of business (and since many of them used personal mortgage loans in their own names, are also completely broke with ruined credit). When you buy a house using borrowed money as a financial investment, you are using leverage, which means that both your potential gains and potential losses are magnified by the proportion that you borrowed with. Investment property comes with an inherent risk in the form of property values, and that risk is greatly increased if you buy the most expensive possible property you can for a given down-payment. Think about it this way: most people think the stock market is a good investment, but would you borrow $300,000 at 6% and put it in the stock market? What happens if two years from now your investments are only worth $150,000 and you are still paying back that loan?
posted by burnmp3s at 2:12 PM on April 28, 2011


We'll talk to an accountant. Both of us would have no problems paying for it down the road. Thanks for the advice.
posted by notnathan at 4:33 PM on April 29, 2011


you can probably use some financial tricks to transfer it to the LLC

It's called a quit claim deed, and it's no trick.

It will, however, have financial consequences for you and your father, so the process should be part of the structure you work out.

An investment property doesn't have the same kind of tax benefits as a primary residence so relative to normal home ownership you are probably not going to get as much of a tax break.

They're qualitatively different, and also different if you're taking the income through an LLC, although the LLC gives you more options than straight ownership and may have tax benefits in its own right, depending on where you are. For instance, you can deduct from your rental income all your expenses, and you can depreciate all upgrades to the property over a number of years. It's quite possible in the early years that mortgage interest, property taxes, and other expenses mean you have a tax loss on the property, which is what most people are looking for in real estate -- something to offset income elsewhere, like from a profitable investment or business.

It is possible I would be living in one of the units and paying rent.

The tax rules here can be tricky, so make sure this aspect is considered. Among other aspects you must pay market rent, or be penalized for accepting less than market.

pretty much all of the real estate investors that tried to maximize their buying power, they are all out of business

To be sure, most of the people who got caught in the housing crash were flippers hoping to capture appreciation of the property. Traditionally, real estate has been an income stream investment. If you think of it the latter way, and the numbers work for you, it can still be a good investment. But property values in the US are unlikely to appreciate much for some time to come, as a rule of thumb.

As for a trust, I think that a springing trust should be considered for your father's interest, or again some means to allow you to buy him out should, say, his health decline. If your father has long-term-care insurance with at least five years of payouts, make the trust activate at that time so that you can avoid the five-year Medicare asset-transfer look-back. In general, it would be wise to consult an elder law attorney at the time of this major investment in addition to a real estate attorney.

But the main reason for a trust here is to protect the assets, not as an option to manage the income flow.
posted by dhartung at 4:38 PM on April 29, 2011 [1 favorite]


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