How Real Estate Partnerships Work: The Pros And Cons

If you’ve thought about buying an investment property to grow your portfolio, a real estate partnership may be a great starting point. These are limited joint ventures that invest primarily in real estate. They bring investors together to manage and financially support their mutually owned venture.

Investing in a real estate partnership has many benefits, but the strategy isn't for everyone. You’ll have to judge if the risks and tax implications outweigh your potential profits.

What Is A Real Estate Partnership?

A real estate partnership is an investment strategy that integrates the strengths of two or more investors into a single property. Typically, partnerships are categorized as either active (also called general) or passive (also known as limited). Active partnerships are where all parties are equally responsible for day-to-day management, while passive partnerships are used as a means to raise capital from investors who are not as involved.

For instance, if you have extensive knowledge of the market and your friend has the capital required to invest, you could be poised for a successful limited real estate partnership.

Tax Implications Of A Partnership In Real Estate

Real estate partnerships are one of the most common types of pass-through entities. Unlike corporations, pass-through entities are not required to pay corporate income tax or any other entity-related tax. Instead, their owners pay individual income taxes based on their share of the profit.

For example, if you have a rental property partnership with one partner that garners $20,000 in total profits, you'll pay individual income taxes on your share, let’s say 50%. That means you pay taxes on half of the profit, $10,000. With sole ownership of real estate, you're required to report the property's net income on your normal tax return (Form 1040), and you’d pay taxes on the full $20,000.

Partnerships differ from sole ownerships, as they are required to file an entity-level tax return (Form 1065) and report the income of each partner with a K-1. Every partner in the investment will then receive distributions of income annually.

Real estate partnership agreements are favored over other types of pass-through entities because they can offer a high return on investment. However, as a result, real estate partnerships can also be subject to high risks.

If you're considering ownership interest in a property, let’s compare real estate limited partnerships to general partnerships to help you decide which one would better suit your needs.

Real Estate Limited Partnerships (RELPs) Vs. General Partnerships

When comparing real estate limited partnerships (RELPs) to general partnerships, you must understand the legal, financial ownership and management differences between the two.

Real Estate Limited Partnerships

A limited partnership has both a general partner and a limited partner(s). The general partner is responsible for the day-to-day operations of the venture, while the limited partner(s) serve primarily as investors. Limited partners are sometimes referred to as silent partners, meaning they invest capital in exchange for a portion of the profits.

The financial liability of a limited partnership relies primarily on the general partner. The limited partners' liabilities depend on their level of investment and involvement in the partnership. These investors are known as limited partners because they have obligations in the venture’s debts and liabilities, up to the amount they invested.

Many real estate professionals prefer the RELP structure because it allows experts to take control of the venture as the general partner, while the other members can just invest their capital as limited partners.

General Partnerships

With a general partnership, there are one or more partners who are considered the owners. General partners are responsible for the day-to-day management and all key decisions for the venture. Therefore, each partner has equal rights and responsibilities.

Unlike RELPs, general partnerships don’t offer liability protections for their partners. In this case, all partners are equally liable for the venture. For example, if one partner is sued in a general partnership, all partners are held responsible. Or if one partner enters a deal and goes bankrupt, the other partners will have to cover the damage. If the other partners don't have the means of covering the damage, their personal assets can be seized as payment.