Limited partnership real estate investment is a common form of business structure used by multifamily investors. It is popular among asset managers, who serve as general partners and who seek investors for their projects, and among investors, who are looking for passive income and welcome a limited partnership role. The general partner’s managerial capability is the chief draw of limited partnerships (LPs). Sometimes LPs are organized for a specific purpose among investors who are already familiar with each other. However, development companies can also be general partners in an LP, and any investor who wants his or her investments handled by a professional manager might join one as a limited partner.
The Benefits of Limited Partnership Real Estate Investment
Besides professional management, an LP has the advantage of limited liability and also offers a variety of tax advantages. Limited liability means that the limited partners’ financial responsibilities to the partnership are restricted to their financial contributions to it. So, if an LP incurs debts that exceed its value, the limited partners will not be obligated to provide reimbursement from their other assets. This protects them (but not the general partner) from the consequences of financial mismanagement, bankruptcy, lawsuits, or any number of other risks.
An LP is a pass-through company and, therefore, is not taxed as a corporation. Rather, investors (the limited partners, who are referred to as members of the LP) pay personal income taxes on their share of the profits. Being a limited partner in an LP is referred to by the IRS as a “passive activity,” and the income it produces is taxed as passive income. This is in contrast not only to active income (salary and wages), but also to portfolio income, which is income in the form of dividends, interest, and capital gains.
Rents and income from real estate limited partnerships are practically the only sources of passive income, which is subject to its own tax rules. Unlike portfolio income, losses on passive activity can be passed through the company, as well as profits. In other words, capital losses can be deducted from capital gains and passive losses can be deducted from passive income. Passive losses can also be carried over into future tax years if they are not extinguished the year they are accrued. Passive losses may result from depreciation, interest paid, or expenses, such as maintenance and repairs.
Tax Reform Offers New Deductions
The Tax Cuts and Jobs Act (TCJA) of 2017 led to several tax changes for investment property owners. Among these are tax deductions between 2018 and 2025 for qualified business income from pass-through companies. The rules are extensive and complex, but income from an LP meets the definition of “qualified,” so members of an LP will be allowed to deduct up to 20 percent of that income.
Only a few LP members will be able to claim the full deduction, however, due to the income limits on the deduction. Meanwhile, the upper income limit to receive the full deduction under the TCJA is $157,500 for individuals and $315,000 for couples. Other LP members may be eligible for deductions as well, but they will need to engage an accountant as it will be dependent on each individual case.
Limited partnership real estate investment offers investors expert asset management, limited liability, and very specific tax advantages. These things make it highly desirable as an investment vehicle, but only certain investors will be able to take advantage of the tax conditions to the fullest. These complexities illustrate the need for expert advice in tax optimization.
At CWS Capital Partners, we are a fully integrated multifamily real estate investment management firm that offers everything from due diligence and multifamily real estate valuation to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We also own and manage luxury multifamily investment communities in major markets around the country and employ a team of experts who can help you hone your investment strategy.
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