What you can learn from this story . . .
• Partnerships are a great way to lower the risk of investing in real estate and an excellent way to share investment costs. But they can bring unpleasant surprises and losses, too. Tread carefully when entering into a partnership.
Forming a partnership can be an excellent option for certain investors. Other investors may prefer to be the sole proprietor or to incorporate Let’s take a closer look at your options so you can decide the optimal structure for your new real estate business.
Sole Proprietorships
When you acquire buildings without a partner, a corporation, or any other business entity behind you, you are functioning as a sole proprietor. You are in the driver’s seat, making the decisions, taking the profits, but also incurring the risks.
Being a sole proprietorship offers the following advantages: (see Case Study You Can Profit)
• You make all the decisions yourself. No one can show up at your door with a load of kitchen cabinets that you didn’t order. No one can rent an apartment to a tenant you wouldn’t approve, or undersell your property.
• Your business is relatively easy to run. Keeping records is not complicated. If you track your expenses, profits, depreciation, and other basic statistics, you can probably manage your business with only the help of an attorney and a tax accountant. You also enjoy one of the basic freedoms we have in the United States: the right to conduct business as an individual.
• You can treat your holdings the same way you treat all your personal property. If you want to give some of your buildings to your children or set them aside in a trust for them to inherit after you die, you can.
Yet, sole proprietorships pose some disadvantages too: (see Real estate partnership)
• You are personally liable for expenses, penalties, and legal liabilities. If your building sits vacant for a year and no one rents it, you will be the only person who suffers the damage of negative cash flow. If someone slips on a patch of ice in the driveway of your building and gets hurt, you are the person who gets sued.
• You don’t enjoy certain tax advantages. All income and expenses are reported on your personal tax return. If you die, your spouse and heirs may have to pay a lot of inheritance tax instead of inheriting all of the money you worked so hard to accrue.
• The rising value of your properties can become a liability. If you divorce, for example, the “on paper” value of your holdings can become a real asset to which your former spouse can lay claim. If you decide to sell properties for a great deal more than you paid for them, you will probably pay capital gains taxes. (You can get around paying capital gains taxes by like rolling your profits through investing in other properties. Consult with your attorney or tax advisor.)
These advantages and disadvantages should be balanced against other options for structuring your business.
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