Investing in California real estate is generally considered a business activity, meaning that it is undertaken for the primary purpose of making a profit, as opposed to charity or recreation. Business activities can have important effects on a person’s life and finances, including taxes and other potential liabilities.
When an individual invests in an ongoing venture like a real estate syndicate or a real estate investment trust (REIT), they are buying equity in an existing business. When one or more individuals engage in their own investment activity, such as by buying a house with the intention of flipping it, they have effectively started their own business.
California business law will treat these ventures as business entities, whether or not the investors create a formal business structure. One individual who embarks on an investment is known as a sole proprietor. Two or more people investing together have, by default, formed a general partnership. California real estate investors need to know which obligations they undertake by becoming general partners.
What Is a Partnership?
California defines a partnership as “an association of two or more persons to carry on as co-owners a business for profit.” Two or more people who operate a for-profit business venture automatically create a partnership under California law, “whether or not the persons intend to form a partnership.” Being a partner in a general partnership means sharing both profit and risk. It is therefore important that all investors in a real estate venture enter into a partnership agreement at the beginning of the venture.
General Partners and the Partnership
Partners owe certain fiduciary duties to the partnership and to one another. This includes the duty of loyalty, meaning that each partner has a duty to work in the best interest of the partnership, to refrain from self-dealing, and to avoid direct competition with the partnership. A partnership may bring a cause of action against an individual partner for breaches of these duties.
Allocation of Profits, Losses, and Liabilities
Under state law, each partner has an account that is credited with the total value of that partner’s contributions to the partnership, and it is charged with that partner’s share of the partnership’s liabilities. Profits and losses are allocated equally among partners, unless the partners have agreed otherwise.
Unlike more formal business structures, such as a corporation or a limited liability company, partners in a general partnership are not shielded from individual liability for the partnership’s debts and other obligations. Each partner is jointly and severally liable, meaning that a creditor or other claimant can seek to recover damages from any individual partner.
Taxation of General Partnerships
Advantages of General Partnerships
From the above description of how California general partnerships operate, we can identify several advantages that they offer over other business forms for people investing in real estate:
– Ease of formation: any two or more people doing business together are, by definition, a general partnership.
– Simplified decision-making process: each partner has an equal voice in management.
– Straightforward taxation: partnerships are not subject to “double taxation” like C corporations.
Disadvantages of General Partnerships
General partnerships are not ideal for everybody, and they bring several disadvantages. The biggest is the lack of any limitation on liability. Each partner could be held fully liable for the partnership’s debts and other liabilities.
More Blog Posts:
Defining “Projects” in a California Real Estate Partnership Agreement, Titles and Deeds, May 18, 2017
Valuing Interests in a Sham Real Estate Partnership, Titles and Deeds, May 14, 2017
Limited Real Estate Partnerships in California, Titles and Deeds, May 7, 2017