You and your brother- or sister-in-law decide to purchase an investment property. Among the first items you must consider is how you will hold title to the property. A thorough understanding of the consequences of the various methods for ownership of the property is essential so that the form of ownership you select does not interfere with your operation of the business or result in adverse tax consequences. Let’s review the basic business forms.
Co-ownership or general partnership. If the two individuals take title to the property in their individual names, they will be considered co-owners or general partners. As co-owners of the property, the consent of both owners will be required to sell the property. The co-owners are each personally responsible for all real estate taxes and other expenses of the property. Further, each is jointly and severally liable for all personal injuries occurring at the property. As to the tax ramifications of such ownership, the parties will each be charged with one-half of the profits, losses, and tax benefits.
Limited partnership. If the parties form a limited partnership, their liability with respect to the expenses and debts relating to the property may be limited, although there must be a general partner whose liability cannot be limited. The general partner can be a corporation formed solely for the purpose of being the general partner. However, if the limited partners exercise any management authority with respect to the partnership or the property, they may lose their protection as limited partners. In a limited partnership, the relative ownership interests of the partners can be different. With a limited partnership, all the profits, losses, and tax benefits relating to the property flow through to the general and limited partners according to their respective interests as defined by their agreement.
Corporation. The parties may also form a corporation to own and operate the property, which will limit their liability for debts and expenses of the property. However, if the corporation generates a profit, the corporation will pay income taxes on the profits, and then the shareholders will be taxed on the dividends the corporation pays to them. The shareholders may, however, elect the corporation be treated as a small business corporation, which allows the shareholders to be treated for tax purposes as partners, in which event all the profits and losses will flow through to the shareholders in proportion to their ownership of stock.
Limited liability company. A limited liability company offers the best features of a corporation and partnership. The members’ liability for debts and expenses is limited to the amount of their capital contributions, and they are not responsible for debts or expenses in excess of those contributions. Further, the members of a limited liability company are permitted to agree as to the allocation of membership interest, voting rights, and tax allocations. For income tax purposes, the members of a limited liability company are treated as partners, so the members avoid the double taxation of a corporation discussed in the prior paragraph.
Whichever form of entity is selected, it is important that the parties have a written agreement with respect to their relative duties and rights, including the sale of the property, buyout in the event of death or disagreement and other events that may warrant a change in ownership. We regularly assist clients in the organization of real estate ventures, and we encourage you to contact us to help you determine the best type of entity for your real estate investment.