How real estate partnerships work: The pros and cons

For people hoping to achieve the American Dream and purchase their own property, investing in real estate has repeatedly proven to be a winning formula.

Maybe that’s because, as U.S. President Franklin D. Roosevelt put it, “Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world.” 

That said, it takes money at the outset to invest in real estate – which is one of the primary reasons people form real estate partnerships.

Investors in partnerships can support each other through joint-owned investment properties, which allow for a larger portfolio – and thus larger profits – while reducing financial risk.

So forming a real estate partnership can be a potentially beneficial financial arrangement, but it also brings risks and liabilities. If you want to determine whether this is the best investment for your lifestyle, finances, and personal goals – well, read on!

What is a real estate partnership?

Before we go too far into this topic, let’s define what a “real estate partnership” actually is: It’s an investment strategy that integrates the assets of two or more investors into a single property.

By combining the assets from two or more people, your partnership will have more capital for you to purchase property. And the more capital you have, the more property you can buy – which provides an opportunity for greater appreciation.

There are typically two types of partners in this arrangement, active and passive.

• Active partner: This partner oversees the partnership’s logistical work, invests the funds, handles the property management and maintenance, and more.
• Passive partner: This member of the partnership largely provides financing for the project and leaves the day-to-day work to the active partner.

In an ideal partnership, each partner would bring their specific expertise int to the deal, thereby increasing efficiency, profitability and – theoretically – success.

Tax implications of a partnership in real estate

If you’re creating a real estate partnership, it’s important to have a solid command of the tax implications. This arrangement is classified as a “pass-through” entity, which means a corporate income tax isn’t levied against it because its profits pass through to the owners. In this definition, that taxes are reported as individual income tax and taxed at the individual rate.

Let’s look at an example: Say you are part of a two-person partnership that earns $10,000 in profits and you have agreed to an even income split. That means your share of the profits – in this case, 50% – pass through to you and you’ll pay individual income taxes on $5,000.

If you had sole ownership of the property, you'd be 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.

However, partnerships file an entity-level tax return (Form 1065) and report the income of each partner with a K-1 form.

In a real estate partnership, income may be split evenly or it may be divided unequally depending on the agreement, each partner’s specific duties, and other qualifiers. When you establish your partnership, you should be sure to create an arrangement that equitably reflects everyone’s work and level of investment in the property.

Real estate limited partnerships (RELPs) vs. general partnerships

There are different types of real estate partnerships – real estate limited partnerships (RELPs) and general real estate partnerships. Both let investors pool money for property deals, but that’s about where the similarities end. In RELPs, some partners just invest money while others run the show; in general partnerships, everyone typically shares control and responsibility equally.

Real estate limited partnerships

A RELP typically has a general partner (who manages the property and makes business decisions) and a limited partner (who provides capital but has few management responsibilities).

General partners face unlimited personal liability for all partnership debts, while limited partners can only lose what they invested. This liability protection makes RELPs attractive to passive investors who want real estate exposure without management headaches or unlimited risk.

General partnerships

General partnerships involve two or more owners who typically share equal responsibility for running the business and making decisions about daily operations. Each partner has the authority to make binding decisions for the partnership, which means everyone shares control – but they also share the workload of managing the property.

The major downside of this arrangement is that every partner faces unlimited personal liability for all partnership debts and obligations – if one partner goes bankrupt or makes a costly mistake, the remaining partners are still on the hook for the full amount.

This lack of liability protection means partners risk losing personal assets like their homes or savings to cover partnership debts, making general partnerships a much riskier choice for investors who want to protect their personal wealth.

The pros and cons of real estate investment partnerships

As with most things, real estate partnerships come with pros and cons.

The pros

• Larger investment: While real estate partnerships can require a larger investment, they can also offer a higher rate of return. Like all arrangements, investing in real estate comes with risk. That said, the more you invest, the higher your potential return.
• Work with partners: Collaborating with others not only creates a larger investment pool, it brings different types of expertise within your group – which can lead to greater success. This diversity in knowledge, skill, and background provides different perspectives that help you spot opportunities and avoid pitfalls that you might not see if you were working solo, ultimately helping position your partnership for higher returns.
• Payment flexibility: Working with a group brings payment flexibility, as each investor can choose how much they want to invest and how they want to receive the funds. One of the benefits of real estate investing is varying levels of flexibility –  some might want to collect returns as quickly as possible, while another may see it as a way to amass tax benefits.

The cons

In addition to these benefits, though, there are downsides to investing with a partnership.

• Potential for conflict: Bringing diverse perspectives together raises the possibility of conflict, as well. More partners mean more opinions, which can bring disagreements. How fractious those become depends on your ability to collaborate.
• Disproportionate level of involvement: Relatedly, it’s crucial that every partner understand their role. When roles are undefined, some partners may take on more day-to-day responsibilities while others may shirk their duties. If expectations aren’t aligned, it can create tension and resentment.
• Difficult termination: Another significant downside to a real estate partnership is the difficulty ending the arrangement. Partnership interests are typically illiquid, meaning shares can’t simply be sold on the open market. Ending a partnership can be messy and complicated.

How to form a real estate partnership

If you’re interested in forming a real estate partnership, here are the steps you should take to move forward.

1. Take inventory of your combined buying power

Conduct a thorough examination of each partner's strengths/weaknesses, skills, and individual buying power. This can help set clear expectations and boundaries for the future partnership. Be sure to set goals related to profitability, as well as individual roles.

2. Develop a real estate partnership agreement

Create a highly detailed real estate partnership agreement that outlines roles and responsibilities, details how to split profits, spells out daily responsibilities, and chronicles your investments. Given the importance of this document, it makes sense to work with an attorney to draft this document.

3. Form a corporate entity

Partnerships must be a legal structure that are created as a legal corporate entity, so don’t skimp on this part. Hire a reputable attorney who can help you file your paperwork to develop your partnership. Also, find an accountant who can manage your tax filings and financial reports.

4. Review, revise, and reiterate expectations

As you might expect, the legal documents related to a partnership are critical. Every partner also need to thoroughly review them and have a clear understanding of their roles and responsibilities.

How to get out of a real estate partnership

Real estate partnerships can pose financial risks and challenges that may overwhelm some members of the group. Here are the steps you need to take if you want to get out of your partnership. 

1. Get a property valuation

By having a clear, third-party understanding of your property’s valuation, all partners know their share of the investment.

2. Determine the best course of action

There are a few ways to exit a partnership, so be sure everyone involved understands each option so the dissolution can move forward amicably.

Buy out your partner

In this first option, you can pay off your share of the partnership to exit it. This may require securing a loan or another type of financing if you don’t have the financial means to do this on your own.

Sell your share to your partner

You also can let your partner buy out your share. This allows you partner to continue with the property without you.

Sell your share to a new investor

If your partnership agreement allows it, you can sell your share to another investor. The new owner of your share will take your place in the agreement.

Sell and dissolve

Partnerships formed as a limited liability company (LLC) may decide to sell their assets and then dissolve the partnership legally. This entails filing paperwork and working with an attorney. If the reason for wanting to end the LLC is a stressed relationship, you may explore legal options, such as a breach of contract.

FAQ

A good way to learn more about real estate partnerships is by exploring the most common questions related to this business structure.

Is a real estate partnership a good idea?

A real estate partnership can be a good fit for people who have enough capital at the outset, possess a collaborative spirit, and can connect with good partners. It is a complicated arrangement, though, so it’s important to explore it before diving in.

What are the tax benefits of a RELP?

RELPs offer significant tax advantages because their pass-through status means owners avoid double taxation.

Are RELPs liquid?

Liquidity refers to how quickly you can convert an investment into cash without losing significant value, and RELPs are generally much less liquid than stocks or bonds. RELP investments typically require you to wait years until the partnership sells the property or find another investor willing to buy your share, which can be difficult and take a long time.

The bottom line: Real estate partnership could be good for you

Successful real estate partnerships can be beneficial in many ways, but it’s critical to have a foundation of trust from the outset, as well as a clear, structured outline of responsibilities and roles. Individuals interested in pursuing a partnership should vet their partner and work with a qualified legal professional to establish a business entity and outline a partnership agreement.

If you’re interested in creating a partnership, contact Rocket Mortgage^® to discuss your options today!