Let’s focus on the possible entity types as they relate to the ownership of rental properties. In later articles we will move on to look more microscopically, but for now let’s make sure you are starting from a strong base. You’ll see below the different entity selection types have pluses and minuses. As a guideline, the aim is to limit liability and protect your property from unsecured creditors.
Also consult with an attorney or a certified public accountant well before establishing an entity and transferring ownership of a rental property. Do note, this guide is not a reasonable alternative for expert council.
Note: This landlord tax guide will not serve to replace the qualified council of a certified public accountant or tax attorney. You should seek qualified professional help when setting up an entity and transferring ownership of a rental property.
This form of ownership is the more common and the most straight forward form of ownership and occurs when you purchase the rental property in your own name. This includes owning the property with your spouse, or as joint tenants or tenants in common with someone else. The big benefit is that this is straightforward, for one it does not require you to file any complicated paperwork or pay any lofty filing fees. The biggest disadvantage to this kind of ownership is that your creditors may be able to force a sale of the rental property if they attain a court order against you, or force you into involuntary bankruptcy.
Legal Entity Ownership
Legal entities include limited partnerships, general partnerships, limited liability companies, and corporations. Let’s look at the difference a bit later. First how about a look at the leading benefit of entity ownership, that being with entity ownership your personal creditors can’t force a sale of a rental property. The only entity type that does not require registration with the secretary of state is a general partnership. Regarding taxes, the entity type doesn’t matter that much because in most cases rental income is taxed on your personal tax return, or “passes through”, See the article titled “Necessary Tax Forms for Reporting Rental Activity,” which is included in the Landlord Tax Guide.
General partnership. A partnership is an association of two or more people to carry on as co-owners of a for-profit business. Generally partnership, each partner will have equal management rights, and are personally liable for the debts of the partnership. And as regards that liability, a general partnership is in most cases not recommended.
Limited partnership. This entity is more complex than a general partnership because it requires both one limited partner and one general partner. The general partner has sole management rights, coupled with personal liability for any resultant debts. While, the limited partner is not personally liable for debts of the partnership and furthermore has no management rights. This entity selection is generally not recommended.
Limited liability partnership/company. A limited liability company and a limited liability partnership are pretty similar entity types, both provide for limited liability to the partners/members. This would mean that you will not be personally liable for the debts of the entity, except in cases when the debt is caused by your own wrongdoing. This form of ownership is often preferable because of limited liability and additionally there are not as many formalities that require observance than with corporations.
Corporations. This form of ownership delivers limited liability and allows for perpetual existence. Although they also require the observance of special formalities so as to maintain the limited liability guard. Thus for this reason that LLCs or LLPs are generally speaking more apt for your purposes. Also worthy of making note is that corporations fall under one of two types: c-corp or s-corp. When a corporation is taxed as a c-corp, it will pay tax on rental income, and then you will pay tax (again) when the c-corp pays dividends. And it is more desirable to side-step the double-taxation trap.