Edmonton Real Estate Investors Association Message Board › What is an LP ?
Joint Ventures (or JVs) or syndications for real estate or other business ventures can be legally structured in essentially 5 ways:
a) a simple agreement where 2 or more parties jointly own an asset, or
b) a corporation that holds an asset and where shares are held by the operator (aka real estate expert) and the investor(s), or
c) in a trust, with a trustee and a trust agreement, or
d) undivided interests, or
e) in a limited partnership
What exactly are limited partnerships?
A LP is a preferred and commonly used way to structure a relationship between willing parties for a defined business venture. It is used to reduce risk, delineate responsibilities and share profits in a predetermined way. It is a well thought out, provincially regulated legal vehicle to raise capital for a venture without the expensive overhead of a public company. Each LP has one general partner (GP) and one or more limited partners.
An LP is like a marriage of multiple parties. Unlike a real marriage, it takes a sense of structure if 34 people marry. One party has the expertise for a certain business venture, in our case, multi-family residential real estate in North-America – the GP. The other parties have a desire to invest some of their capital for significant returns, limited risks and potential tax savings. The GP usually executes all activities of the business venture, reports regularly to the investors and shares the profits with the partners in a predetermined fashion.
In essence, the GP-LP relationship is like a trustee-trust relationship: the trust (LP) holds all the assets, but the trustee (GP) on behalf of the trust (LP) manages the assets of the trust (LP).
Think of LPs as JVs on steroids .. or as fractional real estate !
The benefits to the investors / limited partners are:
a) limited risk – to the amount invested, even in case of a major disaster or law suit
b) clear delineation of responsibility – one party is the general partner which does all the work with a clearly defined fee structure and compensation – usually a combination of (hopefully small) fixed fees and variable, profit oriented share of profits (40% in our case, up to doubling your money, after you have received all your original investment)
c) allocation of 100% of losses for potential tax savings (usually in early years due to startup costs and depreciation)
d) clearly defined time line (up to 5 years in our case)
e) possibility to sell units to later partners at annually set prices (usually higher)
f) existing and well tested legal framework, with oversight by provincially appointed regulators
g) annual reporting
h) regular distributions, likely quarterly Unlike a publicly traded or private company (often with a joint venture contract), capital gains, losses and/or income are flown through to the LP Unit holders in a pre-determined fashion, as described in the next section.
Tax Implications Of An LP Investment - Distributions
The LP agreement that you signed (or intend to sign) provides that income and net taxable capital gains for purposes of the Tax Act will be allocated to LP Unit holders in the same proportion as distributions received by Unit holders.
Distributions may consist of the following for income tax purposes for which T5013 partnership income statements are issued, usually in the latter half of March for the previous tax year
a) distributions that are currently taxable.
b) distributions that are treated as a dividend received from a Canadian or US subsidiary corporation.
c) distributions that represent your portion of capital gains
d) distributions that are not currently taxable and will be treated for income tax purposes as a return of capital
Risks when investing in an LP
Like any JV (in real estate or business) the GP has a lot of control over decision making. The GP and/or its shareholders or managers should have deep experience in the venture space, as well as must be trustworthy individuals as large $ amounts are at stake. All the risks are usually outlined in the LP agreement, and in our case it spans almost 5 pages. Sometimes an LP states time lines or exit options, and sometimes it doesn't. Many reckless syndicators have exploited the innocence of the investing public as well as ridden the bouyant real estate market that camouflaged their inexperience or questionable character traits. As Warren Buffet once said "Once the tide goes out, you know who is swimming naked." Many naked swimmer were seen recently in the real estate ebb !
Costs and Benefits of an LP & RRSP Eligibility
Costs for a simple LP is about $1500 plus $3000 to $6000 for an LP agreement, depending on complexity. The costs are slightly higher to open compared to a corporation, but not much .. maybe 50%. Once larger groups of non-accredited investors are targetted as investors you must have an Offering Memorandum (OM) that costs between $15,000 and $35,000 to develop. The benefit is now that eligible investors in certain provinces can invest with you. Like real estate, LP units cannot be held directly in your RRSP. A separate legal structure is required to hold real estate or LP units indirectly to make your investment RRSP eligible. I may post elsewhere on the securities issues [aggregate acquisition cost, accredit investors, eligible invetsors, ineligible investors, RRSP eligibility ..]
Note / Caution
This is an example only, and does not constitute tax or legal advice. Tax advice can only be given by an authorized professional such as a chartered accountant, lawyer, certified financial planner or like authority. Numbers, returns or profits are not guaranteed and are an example only.
Thomas Beyer, President
Prestigious Properties Group
T: 403-678-3330 E: firstname.lastname@example.org
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Edited by Thomas Beyer on May 11, 2010 1:14 PM