Partnering for cash flow
Last time I said that I would tell you how I plan to buy houses on a large-scale despite having no money to do it. It is an incredibly simple concept. I am going to use someone else’s money. Easier said than done? Perhaps it is. I haven’t actually done this yet, but I certainly plan to. I will keep you posted on how it goes.
One of the major disadvantages of flipping compared to holding rentals is that the property only makes money one way. You sell it, you collect a check. Holding a rental can make money in 5 different ways. Equity capture or buying the house for less than market value; equity buildup or having the principal on the mortgage decrease; appreciation or having the property increase in value after you buy it; depreciation or having a paper loss that is allowed by the IRS; and finally cash flow or recurring rental income. One of the awesome things about real estate is that any of these five ways can be used in partner agreements.
Given that I don’t have any money I really need a property that cash flows. So that gives me four other things to use for negotiation with a partner. I plan on buying properties that have reliable cash flow and while appreciation is nice, I don’t plan to buy properties just for the appreciation. So down to 3 bargaining chips. I am going to aim at keeping the equity buildup as well since that equity is one of the key things to becoming rich, though this is a point where I can be flexible. I can keep it all or share it. The last two methods are my main giveaways so to speak. I would like to utilize real estate to decrease my taxable income, but I think for now that might have to wait. The cash flow is more important to me right now since there are other ways to decrease taxes just by owning a business.
I’m going to focus on the paper depreciation for a second before I detail out the last profit center. In order to give away the depreciation of the property my partner and I will have to form a legal entity together. I believe a Limited Liability Company (LLC) makes the most sense and is the entity I will likely be using, but I can see the argument for a Limited Partnership (LP) or an S-Corp. I won’t go into the differences on those now. LLCs are a passthrough entity as far as the IRS is concerned, so whoever owns the LLC gets all the taxes, both the good and the bad.
Since the taxes flow through an LLC, it is fairly easy to hand over the depreciation to one of the partners. LLCs are also taxed based off of profits, not income. So here is the wiggle room that I will have to decrease my taxable income. Have the LLC utilize the cash flow from the property to pay for things for me such as eating out or providing my cell phone. If all the cash flow is spent by the end of the year there is no income that passes through to me and nothing to be taxed.
The last profit center on a piece of property is the equity capture. I leave this to last because I think it might be a sticky point. What I will be proposing to my partners is that they bring the money for the down payment on the property. In exchange they get the paper depreciation for as long as they wish to receive it. I fully believe that most people will say they want their taxes reduced forever. But in the circumstance where they do want to stop receiving a tax deduction, then I have the equity capture to give back to them as well. If I buy the property right, the equity capture should be pretty close to, if not more than, the down payment they provided to get into the partnership.
There are a few other details in the partnership I am not going to go into here. They are things like property turn over and management and tenant management. The important part of what I am going to try to do is to utilize the different profit centers to create a win win situation. I get some much needed cash flow, they get much needed tax breaks, and we provide safe, affordable, clean housing to those who need it.
I hope this gives you some ideas on how to form a real estate partnership. Decide what you need to keep and what you can live with letting go and use that as the basic structure.
Until next time, take some action. Feel the fear and do it anyway.