In my experience (well, my observation of the experience of others) the one ship that never makes port, is a Partnership. I've a few horror stories about some of the failures I've seen too.... and when I say "horror" that's putting it mildly.
TO start with, understand that long term rental property is always reported on SCH E *no* *matter* *what*.
Next, be aware that both a partnership and a multi-member LLC file the same IRS Form 1065-Partnership Return each year at tax time.
Next, putting a rental in a multi-member LLC is a waste of time and will not give you the legal protection you may think... I don't care what the CPA's tell you. It flat out "will not" protect your personal assets from litigation should you, the other members, or the multi-member LLC be sued by a rental tenant. So don't waste your time with a multi-member LLC. Just establish a Partnership instead.
When purchasing the property, the deed needs to have the name of all partners *OR* the name of the partnership. I prefer the latter because it allows for a change in the number of partners for tax reporting purposes, without having to go through the hassle of changing things on the deed. That's a really big hassle with the mortgage holder, and it's rare of a mortgage holder to allow that.
But the downside of that is, if there's only two partners in the partnership and one of them leaves with no one to replace them, then you no longer have a partnership and the partnership is dissolved. Then the one remaining "owner" reports the rental stuff on SCH E as a part of their personal 1040 tax return. Changing ownership on the deed from the partnership to the one remaining sole owner requires that sole owner to be able to "qualify" for the mortgage on their own merits. For most (not necessarily you) if they could have qualified on their own merits, they would have never agreed to a partnership in the first place.
So if you're going to do a partnership make sure you both have your ducks in a row. You both need to see a lawyer and draft up a partnership agreement that will hold up in court. Here's a few examples of things that need to be covered.
- What happens if one of the partner's die? Will those inheriting his assets also get his percentage of the partnership and the power that comes with it? Do all partners even have a last will and testament?
- What happens if one of the partner's losses their job while the rental sits empty for 3 months? Remember, rented or empty the mortgage payments still have to be made.
- What happens if a partner just decides "I don't want to do this anymore. I quit!"
- What happens if a partner is in an accident and becomes disabled and not only unable to work, but are also unable to "actively participate" in rental activities?
- What happens if a partner is in an accident and ends up in a coma for 6 months or more? They're not dead, so nothing of their share is "inherited" by anyone.
- What if one partner hits the state lotto for $300M and wants to buy the other partner's out? Or better yet, what if they want to buy themselves out of the partnership so they don't have to deal with it anymore?
The above are just a few of the things I'm managed to think of off the top of my head just while sitting here and typing it. But the list could be endless.
