Overview

Overview of an LLC in Real Estate

To create an LLC, you don’t have to be part of a team, you can be a single person as well.  When you are creating an LLC, you are basically protecting your personal assets in case of any law suit.  All the law suits are directed towards the LLC and not to you personally.  An LLC is set up specifically to provide liability protection to its members (hence the term “limited liability.” If the LLC maintains its separation from the personal affairs of the member, LLC members are only liable for the debts of the business entity to the extent of their personal contribution.

This protection is unlimited and can be a real lifesaver when faced with a civil claim from a tenant or third party that is injured in or on your investment property. 

There are some circumstances under which LLC members can have personal liability:

  • If there is no clear separation between the business and the individuals
  • If one or more members personally guarantee a business loan
  • If a member engages in fraud or illegal activities goes beyond the scope of the duties of a member
  • If one or more members has mismanaged the affairs of the LLC.

Members of an LLC are also liable for specific debts of the LLC if they personally sign to be responsible for those debts. For example, if an LLC purchases a building, and an LLC member signs too personally guarantee the mortgage, the member is liable for the loan if the LLC can’t pay. 

Overview of Partnership in Real Estate

Most state laws govern the structure of a partnership.  A decision of the California Supreme Court has defined a Partnership in the following terms:  “A Partnership as between partners themselves may be defined to be a contract of two or more persons to unite their property, labor or skill, or some of them, in prosecution of some joint or lawful business, and to share the profits in certain proportions.”  A voluntary association of two or more persons to carry on a business or venture on terms of mutual participation in profits and losses.

Whether you are officially licensed by a state or have a third party agreement, the activities that you participate in can subject you to unlimited liability. A partnership offers no personal protection of your assets away from the partnership agreement that you create.  A law suit could go against you financially.  In a partnership, each partner has personal liability for the debts of the partnership. In addition, each partner has personal liability for the actions of all of the other partners.

Taxes for Partnerships and LLCs

Partnerships and LLCs are “pass-through” taxing entities. That is, the taxes are passed through to the owners (partners or members) on their personal tax returns.

A partnership files a “partnership tax return” every year on Form 1065, but no tax is due by the partnership. Instead, a Schedule K-1 is generated for each partner, showing the amount of the partner’s share of the profits or losses for the year. Then, the partner files this Schedule K-1 with his or her personal tax return.

LLC’s are not recognized by the IRS as a taxing entity. So, multiple-member LLCs are taxed in the same way as partnerships, passing through the income or loss to each member’s personal tax return. Single-member LLCs are taxed as sole proprietors, filing Schedule C along with their personal tax returns.

LLCs may choose to be taxed as a corporation or an S corporation.

Profit and Loss Distribution for Partnerships and LLCs

For both business entities, profits and losses are distributed directly to the owners. Unlike a corporation, there are no stockholders and no stock is offered to owners.

Registration and Record Keeping for Partnerships and LLCs

If a partnership is not registered with a state, there are no specific requirements for keeping records or minutes of meetings. The partnership may function in any way that works for the partners.

Because an LLC is bound by state requirements and it must maintain a strict separation from the members’ personal affairs, an LLC has some requirements to keep records and to hold meetings. Check with your attorney to see what the requirements are for your state.

LLCs and partnerships formed in a state must make reports to their state periodically. Typically these reports are due either yearly or every other year.

The Limited Liability Partnership: A Special Case

Some states allow partnerships to form a Limited Liability Partnership.  It consists of a general partner or partners and limited partners in which the general partners manage and control the business affairs of the partnership while limited partners are essentially investors taking no part in the management of the partnership and having no liability for the debts of the partnership in excess of their invested capital.  Limited partners may be exempt from liability for actions of other partners. In an LLP, all partners have the same general management responsibilities. Many professionals form LLP’s to protect partners from malpractice claims against other partners.

Attorney Selection and Future Planning

Dealing with legal issues is frustrating and can be really confusing if you are not a legal expert. It never hurts to get solid advice from an attorney that specializes in investment property real estate. As a smart real estate investor, ensuring that the attorney that you select understands the law and knows how to plan for your taxable future will help protect you and your business assets. 

The information in this article and on this site is intended to be general and is not intended to be tax or legal advice. Every situation is different; before making a decision to form a business as a partnership or LLC or another form, talk to an attorney in your state.

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