I received an emai from a reader and, after removing personal information have copied it below along with my answer.

Hi,I read your post online at your blog.

I am trying to get an understanding of how taxes should be thought about
in my investing scenario.  Can you lend me some understanding or advice?

I am entering into a partnership with a realtor/license general
contractor; my role is investor (supply down payment and financing).  We
have established terms and will split the profits 50/50.  In addition,
I have silent partners who have provided me cash to invest.

My question is when we sell the property, and my partner, I and my
silent partners take our applicable distributions of the profits, how does this
get treated from a tax perspective?  In addition, we are thinking it
would be best to setup a LLC for the property.  Are the distributions to
be treated as ordinary income, or treated separately as capital gains?
Is it passive income to my silent partners as they have no hands on activities?
 

My Response

Thanks for contacting me. It is good that you are asking those questions! I have
to tell you that I can not give you legal advice or accounting advice since
those are both licensed professions and I am not the expert you need! What I can do is give you the names of a good real estate lawyer and real estate accountant (I work with them and they
are both extraordinary). I will put those contacts at the end of this email.

I can also point out some things to consider. Since you and your partners are
using this endeavor as an investment that is how you need to view it. Are you
going to buy and sell or buy and rent? If you buy and sell will you then use
the profits to buy another property? If you do there is a way to roll your
profits from the first property into the purchase of the second property so
that you defer capital gains taxes. It is called a 1031 Exchange and it
needs to be set up fairly early in the selling/buying process.

With regard to your last set of questions. Richard, my real estate attorney can
also advise you with regard to corporate structure and the related earnings
issues and Kevin, the accountant, can work with you to maximize your income and
minimize your tax obligations.

While I fancy myself pretty informed in real estate and a good researcher in areas where I am not so informed, I have to defer to the experts in fields that, while complementary to real estate, are outside of my pervue. For things as important as how you form your business and how you treat your finances it is in your best interest to invest in professionals up front. Pay now or pay later, but you will pay! Take care of yourself and your future by working with a lawyer and accountant for multi-partner ventures.
Real Estate Attorney - Richard Pacia, Richard Pacia Law Associates
(401) 728-1600
Real Estate Accountant - Kevin Hundley, Restivo Monacelli (401) 223-2428

If I can be of any more assistance, please let me know. Good luck, it is a great
time to invest in real estate!

Kirsten