BiggerPockets

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

Tuesday, February 17

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.

Comments

1. 

   Joshua Dorkin Reply
   almost 3 years ago

   Great post, Greg! The debate about what business entity is always an ongoing one here on BP. It is nice to get the perspective from an attorney on LLC vs. LP for rental property protection.

2. 

   Frank Gallinelli Reply
   almost 3 years ago

   Thank you for providing an excellent summary of the LP vs LLC issue.

   Just a footnote: The C-Corp is even less desirable than either of these two choices because of the likelihood of double taxation when you dispose of the property. The corporation, as the owner, will be liable for tax on the gain; but you the investor (aka stockholder) will want to dissolve the corp and take out the cash -- and that is typically a second taxable event.

3. 

   Harrison Painter Reply
   almost 3 years ago

   Thank you for sharing this great information!

4. 

   Rob K. Blake Reply
   almost 3 years ago

   Great info...I always used LLCs...now I'm glad I did.

   Thanks again!

5. Greg Boots Reply
   almost 3 years ago

   Thank you for the great feedback. I'll post again before the end of the week covering the only time we should own property in a corporation.

6. Debbie Collins Reply
   over 2 years ago

   This speaks of LLC vs LP for rental property

7. manuel Reply
   almost 2 years ago

   what you recomend if i have a auto repair business its still the LLC good for me ? thanks

8. 

   Ted Akers Reply
   almost 2 years ago

   Very good post.

9. 

   Carlos F. Reply
   5 months ago

   Learned not to use LP. Excellent. That's what I love about this board ... you learn something whether you were looking for it or not.

10. 

    David Wedemire Reply
    5 months ago

    Thanks for the advice. Something to think about

11. 

    Uryss Mitchell Reply
    5 months ago

    Thanks for the advice,but being a NOOB how do I know when I'm ready to start a LLC???

12. 

    Uryss Mitchell Reply
    5 months ago

    Thanks for that advice,but being a NOOB how do I know when I'm ready to create a LLC???

13. 

    Dan Timney Reply
    5 months ago

    I like LP because you can be both the general partner and limited partner at the sametime? As a general partner you can show ownership of 1% and limited of 99%. If sued, who in their right mind go for 1% of the assets.Limited can't be sued. LP is better in my opinion.

14. 

    Shawnn Lynch Reply
    4 months ago

    I would have suggested placing the title to all properties individually in the title of a trust, thereby never allowing the beneficial interest of the holding to be disclosed. Especially when you have a stable of properties. Forming a llc per property and only for that purpose always leaves a question of establishing an llc for protection vs business, unlikely to be pirced, but possible. The trust tax is higher, but provides privacy and protection.

15. Paul Reply
    about 1 month ago

    Where is it in the tax code that a limited partner of a LP cannot "capture depreciation on a annual basis"? What does "participating in the operation of the business" have to do with it? Depreciation is mandatory as I understand it. If it is mandatory but a limited partner can't take it, how is this reconciled?

    Here are two articles that contradict what you have said here:
    http://thismatter.com/money/funds/dpp/limited-partnership-taxation.htm
    http://smallbusiness.chron.com/tax-treatment-depreciation-limited-partnerships-21877.html

    The following link to the IRS website makes no mention of this limitation:

    http://www.irs.gov/publications/p541/ar02.html

    A source for this information would be great.

    Thank you.

16. 

    Bryan Hancock Reply
    about 1 month ago

    Great post! Thanks for sharing.

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