Author Topic: Structure of duplex rental business with family members?  (Read 1566 times)

CCCA

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Structure of duplex rental business with family members?
« on: September 26, 2016, 01:36:19 PM »
Hi, my sister is currently in the process of buying a duplex to live in one side and rent out the other.  Because we are in the SF Bay Area, the cost is quite high.  She is getting significant help with the downpayment from our mother and some contribution from me.  We are trying to figure out the right structure for how to handle a rental business that is jointly owned.   


Right now, the rent from the one half will help to reduce the amount that my sister pays for housing.  i.e. we don't plan to make "profit" in the near-term. 


Does it make sense to set up a partnership? And does it make sense to set up the entire duplex as a rental, with my sister paying rent?  Or just the one unit as the rental business?  My sister will be paying just enough (so that when combined with the rent from the rented side), we would just cover the expenses (PITI) and utilities, etc, so on paper, the business will generate no net income (in the near-term).  When there are no net profits, the business could also be put on one person's taxes and it wouldn't change things significantly, I assume.
 

Another question is if we only make half of the duplex the rental business, can we move around the mortgage interest deduction (for the side that my sister lives in) between the three parties to minimize our taxes?  And can that change from year to year? 


Any thoughts or additional questions that would be helpful for us to think about are appreciated.  I know you guys will have good questions and suggestions, so let's hear them! 







Goldielocks

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Re: Structure of duplex rental business with family members?
« Reply #1 on: October 10, 2016, 01:29:09 PM »
YES!  set up a partnership, or you might find yourself in a "defacto" partnership under the generic rules, and liable for business debts that you never intended.   Losses in a partnership can also be claimed against other income, so if it loses money (today), then pays off in capital gains later, that is to your benefit too.  (shifting taxes to the future)

Also -- as she is living and managing it on site, her unit could be considered a cost of the business, even partially.  Also good for tax deductions on the business income.

Generally, you can't structure your partnership unconventionally, to deliberately minimize taxes that are paid.
You are allowed to reduce your taxes to the full legal extent, but not to structure a deliberate tax evasion.

You could set it up so that you each have 1/3 value, or a pro ratio value of the capital and the income, according to each person's original contributions, then that is fine.    Can't change  this partnership structure without a real reason (other than tax avoidance), and should file papers stating the partnership structure (along with how to dissolve the partnership!  don't forget that important part).


e.g.,
If you wanted to, you could do a break out like this.  Talk to an accountant, too, to determine if net profits are before or after your sister's share of rent is paid... typically I would value ( a modest amount) into the equation and subtract it from her portion before distribution.

Mom -- has a 50% share of capital gains and a 10% share of net profits, as she is contributing 50% of the downpayment, and co signing the lease.
Sis -- has 10% share of capital gains and 70% share of net annual profits, as she is contributing time, no capital upfront, but co signing lease.   
Me - has 40% share of capital gains and 20% of net profits (the remainder), and is not co signing the lease, but contributing management support on occasion, and 50% of the down payment.

Enigma

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Re: Structure of duplex rental business with family members?
« Reply #2 on: October 11, 2016, 06:51:19 AM »
Does it make sense to set up a partnership?
No, not in my opinion.  Your mother and you lending your sister the money would be a better alternative with her paying you back within 5 years.  It will be easier for her all around.

And does it make sense to set up the entire duplex as a rental, with my sister paying rent?
If you go the partnership route then yes.  Otherwise your sister lives rent free due to the venture.

the business will generate no net income (in the near-term).  When there are no net profits, the business could also be put on one person's taxes and it wouldn't change things significantly, I assume.

If it is a partnership then all three of you will need to adjust your taxes to show losses.  Just like Trump losses can be carried over from year to year significantly changing your tax burden.  But now it is a portion of losses given to each of you.  I would expect more headaches, a lawyer, an accountant, and a tax advisor maybe needed.

Note that there are tax credits for owning your home.  Even more credits for living in a duplex that you own.  For example her tax credits would be for living in half a house she owns.  If you create a partnership you will be losses and playing around with those credits that could be worth thousands of dollars.

Goldielocks

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Re: Structure of duplex rental business with family members?
« Reply #3 on: October 11, 2016, 12:32:51 PM »
Hi OP,

If you want to avoid a partnership status, you would need to set up a document indicating the downpayment was a gift, or a personal loan at a minimum interest rate.   BUT, this is a great opportunity to reduce or at least defer some of your taxes, so why not just set up the partnership format that works for you from the beginning?

At least in Canada (where the laws intent tend to align with US laws), you could find yourself as a defacto partner without doing anything.  The fact that you are related may help you argue that it is not a partnership, but better safe than sorry.

Here is an explanation (written by CIFP) of how General Partnerships work :


Establishing a General Partnership

A general partnership is the simplest form of partnership, and it can come into existence without any legal formalities, simply by the action of two or more people carrying out business activities together. A general partnership consists only of general partners. General partners are those who are entitled to take an active role in managing the business, and who have unlimited personal liability for the debts and obligations of the partnership.  NOTE -- liability is jointly and severally meaning each individual can be held responsible for the total debt owing.

The ease of setting up a general partnership

In fact, it is so easy to establish a general partnership that some people may be operating a partnership, even if this was not their intention. A person who became a partner without realizing it could get a nasty surprise when he or she is called upon to cover debts incurred by the partnership.

Example When Arnold was playing golf with Samantha, she explained her plans to develop a piece of property that one of her uncles owned. She only needed another $50,000 to go ahead and the investor would triple his money in 12 months. Arnold wrote out a cheque.

Arnold does not realize it yet, but he is now a partner in a business involved in real estate development. When he does, he will still have no idea with whom or on what terms. The provincial Partnership Act, the terms of which may be totally unsuitable, will govern his business relationship with Samantha. He needs legal advice.


(Note, the above is an excerpt copyrighted by CIFP)