Accounting
When it comes to your personal home, and other real estate, there are several key strategies to owning and protecting your investments, one of which involves the Family Limited Partnership. Regardless of the specific strategy you employ, correct accounting and record keeping is crucial. The following is an excerpt from the Asset Protection Bible, using the example of a FLP, discussing the importance of proper accounting:
“Many different accounting methods may be appropriate, and working with your financial advisor(s) is critical to developing an adequate system of accounting. The following method is a simplified method that many have found helpful.
The property management company collects the rent, pays the maintenance and repair expenses, maintains liability insurance on the properties, retains a reasonable management fee, and writes a check to the owners of the properties (usually the Limited Partnerships) on a regular basis. Out of the management fee, the property management company – generally a C-Corporation – pays for salaries, supplies, and any tax perks to the employees that may apply. The property management company could be filled in the state where the properties are located and would pay all applicable state and local taxes. Frequently, greater management company lawsuit protection is obtained by incorporating in Nevada or Delaware.
The Limited Partnership that owns the property normally pays the mortgage and property taxes. Because a Limited Partnership is a pass-through entity, any taxable event that occurs (such as profits, losses, capital gains, depreciation, etc.) is then passed-through to the partners on a Schedule K-1 and reported on the individual partner’s 1040 annual tax return. Most profits would be reported as passive income and not subject to federal self-employment taxes.
For those investors who plan to own and manage their own properties, it is critical that the accounting between the property management company and the ownership entities be completely separate. Co-mingling of funds between the entities can destroy the best-designed asset protection plan. Consider the type of accounting you would have if you hired someone else to manage the properties; i.e.: you would never pay unreasonably high management fees, you would have separate bank accounts, you would always expect proper accounting and disclosure practices to be followed, and you would look forward to proceeds from your rental properties on a consistent and regular basis. These guidelines are extremely important in situations where the rental real estate is owned by one Limited Partnership and a second Limited Partnership, LLC, or corporation serves as the property manager.”
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