This article focuses on the types of entities for rental property ownership. You’ll see below different types of entities have their respective pluses and minuses. However, the goal in each case is to limit liability and guard your rental property from any unsecured creditors.
Also seek the expert opinion of an accountant or CPA before establishing an entity and transferring ownership of a rental property. Do note, this isn’t a comprehensive replacement for expert council.
Note: This guide wont serve to replace the qualified council of a certified public accountant or tax attorney. You should seek qualified professional help when establishing an entity and transferring ownership of a rental property.
This is the simpler and more commonplace method of establishing ownership. This is when you purchase a property in your own name. A main disadvantage of this type of ownership is that your creditors are able to force a sale of the rental property if they receive court mandate, or they might compel you into involuntary bankruptcy. A main plus to this form of ownership is that the process is simple, without tricky forms or heavy filing fees.
Legal Entity Ownership
General partnerships, limited liability companies, and corporations are all legal entities. The differences between these entities are important. We’ll outline them below. The major advantage to entity ownership is that your personal creditors are not able to force a sale of the rental, considering that you don’t own it. The general partnership is the one type of entity that does not require registration with the Secretary of State. With regards to taxes, the entity type chosen does not matter a great deal because in most cases, rental income “passes through” from the entity and is taxed on a personal tax return (but do note the cautionary note under corporations). Cover the article titled Necessary Tax Forms for Reporting Rental Activity, included in this tax guide for landlords, for more on just how rental income is taxed.
General partnership. The partnership is an association of two or more people to carry on as co-owners of a business for profit. In a general partnership, each partner has equal management rights, but is personally liable for the debts of this partnership. And as regards that liability, a general partnership is in general not ideal.
Limited partnership. The limited partnership is more challenging considering the fact that this form of ownership involves at least one general partner and one limited partner. The limited partner isn’t personally liable for the debts of the partnership, but then again has no management rights. The general partner has sole management rights, along with personal liability for the debts resulting from the partnership. This arrangement also is typically not suggested.
Limited liability partnership/company (LLPs or LLCs). A limited liability partnership and a limited liability company are rather similar entity types, both providing for limited liability to the partners/members. This would mean you will not be personally liable for the debts of the entity, unless the debt is caused by your own wrongdoing. This mode of ownership usually is preferable because of limited liability and also there are not as many formalities to observe than with corporations.
Corporations. Corporations enable limited liability and perpetual existence. But, they require the observance of rigid formalities in order to sustain the limited liability protection. In the absence of these formalities, a court order may very well “pierce the corporate veil” and hold you personally responsible. It is for this reason that LLCs and LLPs are frequently more desirable for your purposes. Furthermore, for taxation purposes, corporations are split into s-corporations and c-corporations. If a corporation is taxed as a “C” corporation, it will pay tax on rental income, and then you will pay tax once again when the corp pays you dividends. You should avoid this “double taxation” loop.
Seatac CPA John Huddleston has written hundreds of articles on various tax subjects. He holds a juris doctorate and a masters in Tax Law from the University of Washington.