Convinced that property values have finally bottomed out in your area, you decide to take the plunge and buy some real estate as an investment. As the saying goes, buy low and (hope to) sell high. In such ventures, one of the earliest and most important decisions concerns which type of ownership entity is best suited for raising capital and securing the financing to fund the acquisition or improvement of the property.
There is an extensive array of possible forms of ownership. They include individual ownership, tenancy in common, joint venture, general partnership, limited partnership, limited liability partnership, limited liability limited partnership, C corporation, S corporation, limited liability company (LLC), business trust, land trust, or real estate investment trust.
For the most part, the limited partnership has been the entity most preferred by investors because it best combines the tax advantages of a partnership with the nontax advantages of corporate ownership. However, the LLC is also a good fit for some real estate investors because, as a hybrid entity like the limited partnership, it has desirable features of other options. Some of the more common forms of holding investment property are discussed below.
Simply holding the property in the name of an individual buyer gives maximum control and flexibility in calling all the shots, assuming the individual has the financial resources to go it alone in making the investment. In this situation, having adequate liability insurance should be a high priority.
Married couples especially may like the option of joint tenancy, with right of survivorship. When one spouse dies, the property can pass directly to the surviving spouse, avoiding the expense and time involved in going through probate. Of course, the other side of the same coin is that the property cannot be inherited by other heirs when a spouse dies.
Using a collection of partners increases buying power and, with it, the range of properties that can be bought. As with any general partnership, there may arise some discord and disagreement among the partners concerning all manner of decisions that need to be made, and each partner’s personal assets could be at risk to satisfy partnership debts.
The legal status of limited partners may appeal to some real estate investors. Limited partners have no say in the management of partnership assets, but they also have potential liability only for the capital they contribute or for any notes they sign. Any real estate losses are allocated to the limited partners, for tax purposes.
Limited Liability Companies (LLCs)
An LLC offers some of the best features from all of the possible choices. An LLC member benefits from the “pass through” of any income or loss from the real estate to his or her tax return. LLC members also enjoy the same kind of limited liability that a corporation’s shareholders have, thus safeguarding their other personal assets.
Any determination of this kind should always involve careful balancing of the specific competing tax, financing, and legal attributes that characterize each entity. What is otherwise suitable from a legal or financing standpoint is often a nonstarter from a tax perspective, or vice-versa. Given the sums of money that can be in play, prospective investors are well advised to spend some additional money on professional advice when choosing the ownership vehicle as they take on the role of real estate investor.