Limited Partnership May Have Pitfalls

Question:In early 1982, our broker made the suggestion that we invest some money in a limited partnership of rental homes. We were assured that we would be getting a quarterly income and, at the end of five years--no longer than six--the homes would be sold. Our investment plus any profits from the sale would be distributed to each shareholder.

The last quarterly check came eight months ago.

In the past week, we contacted the main office that handles the funds and transactions of the limited partnership to inquire if there were a target date for the liquidation of the properties. We were informed that this would probably occur in late 1988 and could extend through 1990.

We believe that the people who inveigled us into the deal used deceit and fraud. None of us would have invested had we been forewarned that our money would be tied up so long. Now we are not so sure that the company intends to sell the properties even in 1990. Another broker told us that his sister invested some money in a similar transaction 16 years ago, and she is still waiting to get her money back.

What outlet(s) do we have in forcing this limited partnership company to relinquish our money at the end of six years? We are convinced that it is unethical for any company to use consumer funds to purchase assets that they control fully and liquidate when it pleases them.--M.P.

Answer:As an investment device, the real estate limited partnership (or syndication) in recent years has become the hottest thing since carry-out pizza. But it doesn’t mean that all of them are good.

Under a real estate limited partnership, a “general” partner puts together a package of income-producing real estate--in your case, I gather, in single-family residences--and then sells “units” in the venture to “limited” partners, usually small investors.

“Limited” simply means that these investors have limited legal liability in the project. In other words, they can’t lose more than their original investment. The general partner holds and manages the property for five to 10 years, during which time the limited partners enjoy the prorated cash flow generated plus their prorated share of the deductibles associated with any income real estate.

When the individual properties are eventually liquidated by the general partner, any appreciation in their value is also split among the limited partners.

There are a couple of things wrong with your complaint, however. Without seeing the offering brochure or circular that the general partner distributed in soliciting your investment, I have no way of knowing whether a specific promise was made in it to begin the liquidation in five years or “no longer than six.” Syndicators, frankly, are rarely that specific because they have no way of knowing just how the real estate market is going to be five years down the road. So they tend to hedge their bets, which gives them the flexibility to wait for a better market.

The other problem with your complaint--and the key one, I’m afraid--is that you made this investment in 1982, and 1987, the target date they gave you for beginning liquidation, is still two years away. So, at the moment, no promise (even if it were a firm promise) has been broken.

Which leaves the question still hanging: If, in 1987, the general partner doesn’t start liquidation, will you then have a legal case against him?

It’s a knotty question, according to W. Jerome Thomas, chief legal officer for the Department of Real Estate in Sacramento, because if the real estate market in 1987 is as flat as it is today, the syndicator might be accused of imprudence if he did begin liquidating the property at that time.

At the moment, it’s a moot point. If in 1987 you want to pursue the matter, however, Thomas added that you’ll have to find out who issued the syndication permit. The odds are that it was the Department of Corporations rather than the Department of Real Estate, which is primarily concerned with the licensing of the broker and salespeople selling the property.

If fraud on the part of the broker or salespeople is alleged, then it would fall under the DRE. But at this point, you have no case at all. And even in 1987 it may be a shaky one.

One of the primary disadvantages of the limited partnership, alas, is the very lack of liquidity that is now beginning to worry you.

Q: Please explain:

1--How do you figure what tax bracket you are in?

2--What does, say, a 20% tax bracket mean?

3--Is there an arithmetic way of figuring the tax bracket?--W.R.C.

A:Hoo boy! Would you buy “How does nuclear fission work?” instead?

As Chris Orozco of the Internal Revenue Service’s taxpayer education department puts it: “There’s no simple way of figuring it because everyone’s ‘bracket’--and the IRS doesn’t really ever talk in terms of ‘brackets,’ but in terms of ‘schedules’ and ‘rates’--is different.”

The “bracket” you’re in depends entirely on your taxable income and has little to do with your gross income. Two taxpayers with the same gross income--and I don’t need to belabor the point--can have radically different taxable incomes and pay radically different taxes.

For instance, both taxpayers are married and have two children, but one rents his home, has few outstanding debts (this helps determine taxes because debt interest is deductible) and doesn’t itemize the few deductions he does have. The other owns his home, has a piece of income-producing rental property, has a host of other deductions and is buying two expensive cars. Guess who pays a higher percentage of his gross income in taxes? The former.

Stripped down to the bare essentials, according to Orozco, let’s determine the bracket for a single taxpayer with no exemptions except for himself. “In this case there would be no tax at all until he has a taxable income of $2,300 a year, or a gross of $3,300 to account for his own $1,000 exemption. And then the rate begins at 11%.” But taxable income is just one factor in figuring your tax bracket.

Previous Return

In actuality, Orozco points out, there’s really only one way to determine exactly what bracket you are in, and that is to go to your tax return last year and work backwards. Go to the line where your “adjusted gross income” is listed, because this will have taken into account all of your exemptions and deductions--including those for mortgage interest, your IRA and what-have-you--and is your taxable income. Now divide that by what you actually paid in taxes, and you’ll end up with your percentage tax bracket.

Why a neat and clean way of estimating all of this isn’t really possible is because of the progressiveness of the whole tax structure.

For instance, here’s how the IRS in its “Employer’s Tax Guide” instructs an employer to withhold taxes for a married employee who is paid weekly:

If the amount of wages is: not over $46, the amount of income tax withheld shall be zero.

Over $46 but not over $185, the amount withheld shall be 12% of the excess over $46.

Over $185 but not over $365, the amount withheld shall be $16.68 plus 17% of the excess over $185.

Over $369 but not over $454, the amount withheld shall be $47.96 plus 22% of the excess over $369.

Over $454 but not over $556, the amount withheld shall be $66.66 plus 25% of the excess over $454.

Over $556 but not over $658, the amount withheld shall be $92.16 plus 28% of the excess over $556.

Over $658 but not over $862, the amount withheld shall be $120.72 plus 33% of the excess over $658.

Over $862, the amount withheld shall be $188.04 plus 37% of the excess over $862.

So, there you have it: tax brackets of 12%, 17%, 22%, 25%, 28%, 33% and 37%. In what tax bracket does the employee fall who earns $572.85 a week? The 28% bracket? Not necessarily, because we still don’t know what deductions are involved.