How to Own Real Estate Investments
Proper Form of Ownership Essential for Wealth Creation, Protection
Sep 4, 2008
There are many ways to own real estate, including as an individual, a partnership, and a corporation. There is also great variety among partnerships and corporations. All of these forms of ownership have particular advantages and disadvantages in terms of protecting assets -- personal bank accounts, homes, and the like -- and tax consequences. Although it is highly advisable that attorneys and tax professionals be consulted for guidance in selecting a form of ownership that suits individual needs, smart real estate investors need to be familiar with the forms of ownership that are most commonly utilized.
Sole Proprietors, LPs, S Corporations, and LLCs
Sole proprietorship: Buying property in the name of one person or in the names of a married couple or two or more individuals is the easiest way to start investing in real estate. The names of the individual owners are listed on the deed to the property, on the mortgage documents, on the property insurance policy, and in all of the relevant government records. However, just because sole proprietorship is the easiest form of ownership does mean that it is the best way to go. Sole proprietors are personally liable for claims made against them by creditors, persons injured on the property, and tax entities. In other words, being a sole proprietor does not put personal assets beyond the reach of others.
Limited Partnership: When two or more people invest together in a business or real estate venture under the terms of a partnership agreement, they create a separate legal entity. In a limited partnership, or LP, there is at least one “general partner” and one or more “limited partners.” The general partner is authorized to negotiate for and buy properties in the name of the LP and to handle the day-to-day management of the LP and its assets. Moreover, the general partner has unlimited liability for the activities of the LP. In contrast, limited partners have no management responsibilities and are liable for the LP's activities only up to the amount of their investments. The LP itself is not taxed; instead, the taxable income and losses of the LP pass through to the partners, who pay their pro rata share of any taxes that are due.
S Corporation: The creation of any type of corporation involves adherence to legally mandated formalities, such as the filing of articles of incorporation, the issuance of shares, and the appointment of directors and officers. The owners of a corporation enjoy almost total immunity from personal liability. S corporations receive special treatment under federal tax law. Unlike other corporation, which are taxed in their own right, an S corporation passes its tax liability through to its shareholders, and the losses that pass through to the shareholders ordinarily are limited to the amounts that they invested.
Limited Liability Company: This entity, also known as an LLC, is a type of hybrid form of ownership designed to provide investors with the same protection from personal liability that is available through a corporation. Moreover, as with an S corporation, the tax liability of an LLC passes through to the investors. An LLC is more simple, less formal, and less expensive to set up than a corporation. It can even consist of one individual. These are some of the reasons why many real estate investors prefer the LLC form of ownership.
Additional Asset Protection
Some of the other ways to protect assets include:
- limited liability partnerships
- family limited partnerships and family savings trusts
- separate LLCs for the purchase of different properties in a portfolio
- different forms of ownership for properties in a portfolio
Note: Not every state recognizes all of the entities mentioned in this article.
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