LLC or LP? Which Entity is Best to Protect my Rentals?

As an investor in long term holds I know the importance of making sure that I am protected from any liability exposure associated with my investment property. The question becomes should I use a Limited Liability Company or a Limited Partnership for asset protection purposes with my rental properties?

Having consulted and educated thousands of investors across the country I have seen both LLCs and LPs used to hold rental properties. Both entities are extremely well situated to protect properties from unrelated liability exposure (called outside liability). However, there are two distinctions that make LLCs better suited to hold rentals and lease options.

The first benefit deals with inside liability exposure. This type of harm occurs within the entity itself and is associated with the property. In a Limited Partnership with have two classes of partners: General Partners and Limited Partners. Limited Partners are able to contain their risk exposure to what they have invested in the business because they are completely passive investors. As passive investors, the Limited Partners are not able to participate in the management or running of the business. The General Partner is in total control of how the business is to be run. In exchange for the control, the General Partner is subject to unlimited liability exposure. Therefore, if a tenant is injured not only can the General Partner lose his or her investment in the business, but the General Partner can have all of his or her personal assets at risk as well. The way to avoid personal unlimited liability is to use an entity such as a corporation to serve as the General Partner. Conversely, an LLC has Members and Managers who are both protected from unlimited liability exposure if an injury occurs within the LLC.

The next distinction is directly related to our tax benefits of holding long term properties. As investors, we are able to capture the depreciation of our long term holds on our 1040 returns (subject to income thresholds). In order to be eligible to capture the depreciation we must have some participation in the operation of the investment property. Unfortunately, I encounter many people who have gone to their local attorneys and those attorneys completely ignored tax consequences and placed the rental properties in LPs for asset protection. If you place your rental property in a LP and you are the Limited Partner, you lose your ability to capture your depreciation on an annual basis because a Limited Partner cannot participate in the operation of the business. This is a huge mistake when it comes to tax planning. However, if you use an LLC for your investment, you do not lose the ability to capture your annual depreciation because even a passive Member within the LLC can participate in the operation to an extent that would allow for the full capture of the annual depreciation.

When it comes to proper planning for asset protection, be diligent to ensure that you will not only receive the best level of protection but that your plan does not hinder proper tax planning. In almost all circumstances, LLCs are the preferred entity to provide not only asset protection for your investments but also solid tax planning.

Is My Home Protected in a Lawsuit?

While educating investors on asset protection throughout the country, one of the key questions that I am often asked is whether or not someone’s home would be protected in an individual lawsuit. Unfortunately, the answer to that question depends greatly on what state you call home and how much equity you have in your primary residence. All states have a "Homestead Exemption" in which the state law, either through statute or case law designates a specified amount of equity that you may have in your primary residence to prevent your home from a forced sale to satisfy creditors. There are five states that provide the greatest level of protection: Florida, Texas, Iowa, Oklahoma and Kansas. In these states you will have virtually total protection regardless of the amount of equity that you have in your property. However, if you do not live in one of these states you are going to have a varying degree of protection. For example, if you live in California, are single, and special circumstances do not exist, your home would not be protected if you had more than $50,000 in equity.Therefore, when determining if your primary residence is going to be protected in a potential judgment situation, you must first determine the amount of equity in your home and then look to the law of your home state.

Asset Protection Techniques

LLC or LP? Which Entity is Best to Protect my Rentals?

Is My Home Protected in a Lawsuit?