Posted on April 26, 2021 @ 04:34:00 AM by Paul Meagher
There are different names for Real Estate Limited Partnerships (RELP). It might also be called
Real Estate Joint Ventures or Land Development Partnerships. There are probably other terms.
I am using the term Real Estate Limited Partnership because it better highlights the legal structure of the company as a limited partnership.
In general, a limited partnership is formed based on two main types of partnership agreements:
- An agreement where all partners are general partners and have similar rights, obligations and liabilities.
- An agreement where there are two classes of partners:
- One or more general partners
- Limited partners who mostly help fund the venture, are not involved in day to day operations, and have limited liability in the event that the losses of the company exceeds their investment.
Most of the time, when investment articles discuss real estate limited partnerships they are referring to the second arrangement which is is used to fund larger real estate projects or a portfolio of real estate projects. An arrangement where all the partners are general partners is also an option for real estate investing and I would argue should also be mentioned when discussing options for how a real estate limited partnership might be structured, especially for smaller scale real estate projects.
One of the main reasons to create a real estate limited partnership as an investment vehicle, versus incorporating, is because it can be easier to flow income and losses directly to the partners. A corporate structure may reduce revenue distribution because income is taxed at the corporate level before it is distributed to the partners (i.e., double taxation). A corporate structure also makes it difficult to claim the losses associated with the real estate development in your personal income tax filings, where a limited partnership generally allows losses to "flow through" to the partners to offset personal income taxes.
A drawback to using a limited partnership versus incorporation for real estate development is that you may be exposed to more liability if something goes wrong. When setting up a Real Estate Limited
Partnership as an investment fund, they can be structured so that the general partner is a corporation that is involved in financing and managing a portfolio real estate projects while the limited
partners enjoy limited liability while investing in a diversified portfolio of real estate investments.
Real Estate Limited Partnerships may sound complicated, but in my own case, me and my wife both invested in and own a secondary farm property that could be viewed as a form of real estate limited partnership involving two general partners. We have invested over the years to getting the farm setup to make money and have been able to claim these development losses on our personal income taxes. This is because
the losses from our partnership "flow through" to the partners. The farm as an entity is not taxed like it would be if the farm was an incorporated entity. Where farms chose to use a limited partnership structure, it is common for the owners to be general partners. Some farms may chose to incorporate to limit liability and to limit taxation of income to corporate levels if the farm is making a good income.
There is much more that could be said on this topic, but the point of this blog was to raise awareness on three topics:
- There are different ways to setup a real estate investment vehicle. A limited partnership structure may have certain advantages from the point of view of claiming losses during development and income distribution when you start earning income. Being able to claim losses associated with development lowers the break even point for your investment. To get back your money, you don't need to get back the initial amount you put into it if the losses you can claim offset income taxes you might otherwise have to pay in.
- An important consideration in private investing is the extent to which income and losses "flow through" to the investor. A limited partnership often allows income and losses to "flow through" to investors where this is less direct or impossible for an incorporated company.
- If you own some land that you want developed, a real estate limited partnership is one way you might want to structure the investment vehicle. For example, your stake might be the value of the land you currently own, to be matched by an equivalent amount from one or more investors who supply the amount of capital required to develop the project to the point of a liquidity event - the sale of the real estate or the initiation of income streams from the development.
I am not an expert on these topics so I would advise you to research these topics on your own and form your own opinions. I do think it is worth the effort to research further because it is easy to assume that incorporation is always the way to go when there are also some advantages to limited partnership structures depending on your situation.