Forming Limited Partnerships - A Smart Move for Entrepreneurial Owners
By: MTI Construction Services Inc.

Imagine owning a state of the art, well located building in which you and several partners can charge a lease rate at full fair market value. You've signed a ten year lease with a credit tenant which contains generous annual bumps. The lessee also takes great care of your building with an active preventative maintenance program. Sound too good to be true? Think again. Astute corporate officers - and even families - are taking full advantage of real estate, accounting, and tax laws by forming limited partnerships. Through this alliance, the limited partnership is able to purchase the real property of the corporation, and subsequently implement strategic lease back terms. This article will outline some of the benefits that several MTI clients have realized by taking this proactive step.


Accounting Advantages
Forming a limited partnership to purchase the building essentially takes the asset outside of corporate control. While the building is placed on the books of the partnership according to its cost, the property is not subject to evaluation by the corporation's lenders. Since the building is being leased by the corporation, the asset comes off the corporation's books. Fixed assets, such as property, are treated as long term assets according to GAAP. Having the fixed asset on the books - especially those which pertain to levels of liquidity - could skew some financial ratios and possibly weaken the balance sheet.

MTI understands the complex financial requirements of our clients and can actually assist the company with our open book pricing policy. For example, many of the leasehold improvements constructed within a building are subject to different depreciation schedules than permanent fixtures. In order to maximize the accounting benefit to the partnership, financial executives need detailed breakdowns of these improvements.


Financial Advantages
One subtle, yet significant benefit to forming a limited partnership is the ability to collect additional compensation, over and above salary and bonuses. By charging the corporation a lease rate at a premium over their mortgage costs, the members of the limited partnership will reap a significant monthly dividend, just as a landlord that owns real property would. The lease rate charged, however, must be realistic. The IRS constantly checks for evidence of "unreasonable" forms of compensation, especially in C corporations. Although this dividend is taxable, the limited partners may choose to invest it to pay down the mortgage, building equity at a faster rate.

Any income realized by the limited partners is taxed as net rental income and would be shown in Schedule E of their federal tax returns. Because of the structure's flexibility, the limited partners may elect not to raise lease rates, so they can defer income to the following year.

The limited partnership also has the ability to refinance an existing mortgage on the property, taking advantage of future drops in the cost of capital. After refinancing, the partners can either pull out some of their built up equity in the form of cash or place themselves in a more advantageous long term position by widening the spread between building revenue and financing costs.


Tax Advantages
For most family and some corporate partnerships, the purchase of a production or distribution facility represents the largest single financial transaction they will undertake in their business careers. It is crucial for them to realize the full benefit of the asset, especially as it relates to long term estate planning. The limited partnership is one way that a family can ensure an orderly and long term transfer of a significant asset to their heirs. Although limited by IRS rules to a lifetime maximum of $600,000, transfer of partnership can put a significant dent in the estate taxes that would be incurred at death. This is a vital asset to the heirs as in many cases the capital gains taxes triggered are so onerous that the successors have no choice other than to sell off assets to pay taxes.

There are other vehicles besides a limited partnership to help business owners leverage the asset value of their facilities. Please consult your accountant and attorney for complete details, including restrictions and limitations. A limited partnership is not for everyone, but for those who do opt for this structure, substantial benefits are possible.

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