Passive Methods of Investing in Real Estate

An investor can invest in real estate as an individual or as someone’s partner and form a society.  These forms involve an active participation of the individual. However, there are passive forms to invest in real estate and that do not need to involve the investor in the management of real estate.

These passive forms of investment in real estate are the limited partnerships and the real estate investment trusts.

Limited partnerships
Investors that do not have the required time or the inclination to actively manage their real estate investments could consider investing in limited partnerships.

A limited partnership is a business entity that is owned and administrated by general partners which sell shares to limited partners to join capital to be able to buy real estate properties.

General partners possess an unlimited responsibility, while the limited partners have unlimited liability. In other words the most that a limited partner can lose is the  amount of his investment. Changes in the tax codes in 1986 removed the tax shelter benefits for the ownership of real estate limited partnerships for limited associates.

The real estate limited partnerships generally incur in net losses due to great expense in appreciation (for tax purposes, accelerated depreciation methods are used which generate larger deductions in the early years of the asset than straight line depreciation).

Because of the changes occurred in the tax code in 1986, passive investors in real estate limited partnership can no longer compensate their losses with their total income.

Losses can only be compensated by other passive incomes. At a great extent, losses generated can be due to depreciation expenses, but  losses do not require of the use of cash, therefore they generate positive flows of money, which are paid to the limited partners as a return of capital (not terrible).

When properties in a real estate partnership are sold the appreciation of its value is treated as gains of capital.

Taxes on limited partnerships are complex and the investors interested in real estate passive  investments should explore REITs, where rules about taxes are not so complex. Another disadvantage for the real estate partnership is the high up-front fees and the commissions charged by the partnership. The range of the honoraries could be between 5 and 20%.

Investors must be more careful when investing in blind pool limited partnerships in which real estate properties are not bought with the funds put by the limited partners. The limited partners invest their capital so that later general partners use this capital to buy the real estate known as blind pool.

Potential investors should get a guide that specifies the real estate projects that the general partners pretend to buy.

Another procedure for potential investors is to research the historical records about performance of each one of the general partners & if anyone has or has had a legal process against him.