In my opinion, you should never buy any form of real estate investment in your own name. Putting an apartment property in your own name tells the world that you own something and puts what you own at risk. You need to protect yourself. In this series, I’ll highlight 6 different entities in which you can buy properties, and the advantages and disadvantages of each.
Trusts
Trusts are formed by two or more individuals known as beneficiaries. The property is managed by a Trustee who may or may not be a beneficiary. Trusts are a very common form of ownership for smaller apartment buildings.
Advantages
- No double taxation – income is reported on a personal tax return via a K-1 Report.
- Limited Liability.
Disadvantages
- Trustee holds absolute power and has the ability to sell the property without consent of the beneficiaries.
- May be difficult to finance.
S-Corporations
An S-Corporation is a separate legal entity but not a separate tax entity. An S-Corporation can be owned by an individual or a group of investors.
Advantages
- No Double Taxation – Income is reported by shareholders on their individual tax returns. If certain requirements are met, the income of the property is not taxed at the corporate level.
- Limited Liability.
Disadvantages
- Income from real estate rentals cannot exceed 20% of gross income. Not a common form of ownership entity for the purchase of apartment houses for long term holds.
General Partnerships
General Partnerships are non-taxable ownership entities for two or more investors. Each General Partnership is regulated by the individual state in which it resides. A partnership agreement is needed and should be drafted by an attorney. Each partner is a general partner and shares equally in the management of the property. Title to the property is held in the name of the partnership and not individually. Each partner owns a share of the partnership. They do not own interests in the property itself, just the assets of the partnership. This becomes an issue if one of the partners needs to leave the partnership. To protect everyone’s interests, terms of exiting the partnership should be clearly spelled out in the general partnership agreement.
Advantages
- Easy to run and low cost associated with start-up.
- No Double Taxation – the partnership is not a tax paying entity. Each partner reports his or her share of taxable income on their personal tax return through a K-1 filing.
Disadvantages
- Unlimited Liability – Each partner is responsible for all the debts of the partnership regardless of the amount of money invested.
Limited Liability Partnerships
A Limited Liability Partnership is formed when two or more investors create a partnership agreement for the purpose of a Limited Liability Partnership. Limited Liability Partnerships are regulated by each state in which they exist. This is a very common form of ownership for real estate investment. They differ from General Partnerships in that one partner takes on all management responsibilities and all of the liability of the partnership. The other partners are shielded from risk and therefore have limited liability. Because of this, the managerial person is compensated for taking on the role as managing partner and taking on unlimited risk.
Advantages
- Limited Liability Partnerships allow for additional compensation for the general partner who takes on the additional risk.
- Limited Liability for limited partners.
- No double taxation – distributions are reported on individual tax return via K-1 reports.
Disadvantages
- Limited partners have limited control.
- They can be costly to form and operate.
- Obtaining financing in the form of the partnership can be difficult.
- The general partner has unlimited liability.
- Lack of liquidity for partnership interests – there is virtually no resale market for limited liability partnership interests.
Limited Liability Corporations
Limited Liability Corporations are the most popular entity of choice for investors to own real estate. The main difference between a Limited Liability Partnership (LLP) and a Limited Liability Corporation (LLC) can be seen in the name of each. A LLP is treated as a partnership while and LLC is treated as a corporation. An LLC allows each member to be involved in management activities. The documents that must be created are the articles of organization and the operating agreement. Some states allow the formation of an LLC with only one investor, while other states require two or more investors to from an LLC. One of the key benefits is that limited liability is allowed for each member of the group.
Advantages
- LLCs are allowed to operate with fewer corporate formalities than are required for C- and S-Corporations.
- No double taxation.
- All members are active in management of the asset.
- Limited liability given all group members.
Disadvantages
- Low liquidity.
- Costly to form and operate.
- May be difficult to obtain financing.
Sole Proprietorship
Sole proprietorship is a single person owner. This is the worst kind of ownership entity for real estate if you want any form of protection for your assets. That being said, there are some benefits to sole proprietorship.
Advantages
- Easy to finance.
- Tax reporting is on the individual’s return.
- No management conflicts.
Disadvantages
- Unlimited liability – courts may go after other assets to settle disputes.
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