Buying a rental w/ a partner: Business options??

[Andrew R.]

Hi, I'm looking to go in on a rental property w/ a partner, I'm hoping for some tip and pro/con on different organizational structure: Details--this partner and I own our current residence (30yr mortgage, not married, we are on title 50/50 right now. We are looking to start small and purchase 1 investment house around 100k (So not a huge business!), We will use a mortgage and split all expenses and earnings 50/50. So, we would need a business arrangement that would allow us to qualify for loans, get insurance, and to earn some individual money from the proceeds. Tax advantages and liability protection issues are important, as well as keeping costs low--LLC fees are very expensive in our state. What about LLPs? Partnership? Thanks for any and all leads!

[Brian Schmelzlen]

Hi @Andrew R. and @Account Closed,

The LLC tax in California is expensive ($800 per year), but an LLC is probably your best choice for owning rental properties. I will give a brief overview of the other options though:

C-corporation: This is a separate legal entity that will file and pay its own taxes.  It offers great liability protection, but it is subject to double taxation (it pays taxes itself, and then you pay taxes when it distributes money to you).  This is generally not a good vehicle for real estate investing.

S-corporation: This is a separate legal entity, but it is also a pass-through entity.  For California, you will pay the greater of 1.5% of net income or $800 to California annually (except for the first year which is just 1.5% of net income).  Because it is a pass-through entity, you do not have the double tax issue.  It also offers great liability protection.  However, it does not have the flexibility that a lot of real estate investors need for rental properties.  If you ever need to take the rental property out of the business, for tax purposes it will be treated as if the S-corporation sold the property to the owners.  Also, all distributions from the business have to be "pro rata" to their ownership interest, which occasionally causes owners issues.

LLC: This is one of the most flexible investment vehicles. It is a pass-through entity, so you do not have to worry about double taxation. It also offers great liability protection as long as you follow the formalities. For California, you will pay an LLC tax of $800 per year, and if your revenue (not profit) is high enough you will also have to pay an LLC fee. Generally, you can put property into and take property out of an LLC without tax consequences. I like this vehicle for rentals, but not for fix and flips.

LLP: This is not available to real estate investing. It is limited to certain types of professional business that are specifically excluded from operating as an LLC, and it requires that the business maintain an insurance policy.

General partnership: I am not going to get into this one too much.  Just don't do it.  It means that you would have liability for the actions of your partners.

Limited partnership: In a limited partnership, there is a general partner who is personally liable for the partnership, and limited partners who are not.  The limited partners are excluded from participating in the management of the business, but they cannot lose anything more than their investment in the business (no personal liability).