Property, leasing, oil partnerships are popular but risky for IRAs
If one of the best things about an individual retirement account (IRA) is saving taxes, what better way to do so than with a limited partnership whose sponsors have years of experience in saving taxes for their clients? That's the kind of thinking sponsors of limited partnerships hope will attract a significant part of the IRA market, particularly in real estate, equipment leasing, and oil and gas. In the relatively short time IRAs have been available to the public at large, the limited-partnership business has responded with a wide range of offerings aimed at this market.
To do so, however, the business has had to place new emphasis on a type of partnership it had not used much before and to make some other alterations.
Still, limited partnerships are not for everyone, particularly for less-sophisticated investors -- the minimum-asset standards of some limit them to upper-middle-income people and above -- and some financial experts believe they may not be for anyone.
The most common form of limited partnership is the leveraged deal, which is made largely with borrowed money. This provides tax write-offs now and income later on, assuming the deal works out as advertised.
But using borrowed money in an IRA, where tax deductions for interest are nonexistent because IRAs are already sheltered from taxes, is considered ill advised.
``It's rather pointless,'' one broker says. His firm sells limited partnerships to the IRA market, and he still doesn't like them; hence he asked not to be identified. ``But you can have a limited partnership that isn't tax-sheltered at all.''
It is this type of partnership, known as the ``unleveraged'' deal, that is attracting most of the IRA money today. Here, 100 percent of the money is raised before the real estate, oil well, or business equipment is purchased. Like leveraged limited partnerships, these are sold by brokers and financial planners. They have been selling pretty well, too. In 1982, real estate limited partnerships that could be used for IRAs had sales of $979.3 million, says Fuhrman Nettles, vice-president of Robert A. Stanger & Co., the Shrewsbury, N.J., publisher of The Stanger Register, a guide to limited partnerships. Those 1982 sales accounted for 37 percent of the market in real estate partnerships.
The next year, limited partnerships designed for IRAs had sales of more than $1.9 billion, for 43 percent of that market. Last year sales climbed to $3.3 billion, for a 58 percent share, Mr. Nettles said.
While a sales record like this indicates a fairly wide acceptance of limited partnerships as IRA vehicles, there are still some points to remember about them.
First, and perhaps most important, is the question of liquidity, or the ability to get your money out when you want to. When it comes to retirement accounts in particular, many people tend to watch them very carefully, more concerned over any negative performance than they would be with a general investment account. If things start to go bad with an equity mutual fund or a self-directed brokerage account, the customer can almost instantly retreat to a money market fund or time deposits at the bank. Even if the retreat is not a good idea from a long-range perspective, if it allows the individual to sleep better at night, it's worth it.
With a limited partnership, however, getting out early may not only be bad strategy, it may also be impossible, at least without risking a loss of principal. Some limited-partnership deals take several years before they start to generate income. In the meantime, the customer is watching the value of his investment slide as management buys new properties and pays various expenses.
``As far as IRAs go, I think limited partnerships are a very poor investment,'' says Jeb Brooks, president of Equity Resources, a Boston firm that provides a secondary market for private limited partnerships. ``The combination of high up-front fees and the lack of appreciation in assets for a minimum of a few years works against the investor. . . . In some deals, if you put in $1,000, the day after your investment is worth $750.''
Of the three most commonly used vehicles for IRA limited partnerships (real estate, oil and gas, and equipment leasing) real estate is considered the area where investors have the best chance of finding good deals. ``I would put equipment leasing and oil and gas well behind real estate,'' said Nettles. ``Until the price of oil and gas stabilizes, I'd stay away from that one.''
But even with real estate, financial advisers caution, investors should know something about how limited partnerships work and how the real estate market works and be able to compare offerings. In other words, these are for people who know what they're doing and have sufficient income to cushion unexpected problems.
For example, at Realty Income Corporation, an Escondido, Calif., firm offering limited partnerships to the IRA market, investors are required to have at least $30,000 in annual income, plus $30,000 in assets, not including their home or cars. If they are not working, they are required to have at least $75,000 in assets, with the same home-and-car exclusions, says Gerard W. Delong, senior vice-president and national marketing director.
Liquidity is something that should be considered, Mr. DeLong acknowledges. ``Any kind of investment in real estate carries a certain amount of illiquidity,'' he says. ``It's basically a different kind of situation'' from stocks or mutual funds. While the leases behind the Realty Income deals vary in length, they average about 20 years, DeLong says. The minimum is about 15 years, and they can run as long as 25 years.
Does this mean investors cannot get out before 15 years? Not necessarily, DeLong points out. His firm maintains an ``emergency pool of cash'' in every partnership, so that if an investor has some kind of emergency or hardship, he or she can simply write the firm and have a check sent back almost immediately.
Other partnerships are beginning to develop relationships with outside firms that maintain a secondary market in limited partnerships, says Mr. Nettles at Stanger. So if you can't sell your shares back to the original partnership, you may be able to sell them to someone else through one of these firms, although you still may incur a loss.
Otherwise, any earnings generated by the partnership are sent back to the custodian (which can be the investor's own broker) and can be passed on to other investments within the IRA or placed in a money market fund, where they await the next partnership offering. In any event, the earnings must be kept within the IRA to avoid withdrawal penalties and taxes.
If you choose or are forced to pull out of a partnership early, remember that you may end up getting out less than you put in. So it is important to check carefully the track record of the firm putting the deal together, to see what has happened to previous investors who left early. This won't guarantee what will happen to you, but it could be reassuring to know how the past record of a firm you are considering compares with some others.