LLC, S-Corp, or LP Holding Company?

Question

I'm just ending college in May, and my friend and I are looking to buy our first investment house in a partnership within the next year. Before we do that, I want to be protected from as much liability as possible and reap any tax benefits from having a corporation. I thought of two ways to structure our partnership; creating either an LLC or S-Corp with a 50-50 share of interest between us, or creating an LP with both of us as equal limited partners and either an LLC or S-Corp as the general partner.
Now from anyone who has experience in holding their RE (in this case probably single family) in a corporate entity, what is the most practical method of setting up this structure in order to get both tax benefits (preferably pass-through), protection from liability, and as little trouble as possible if it ever had to dissolve?
And are there different methods for different kinds of RE?

Account Closed · Answer

Good advice Christian.

Christian Malesic · Answer

Spend the time & the money and do it right out of the gate.

I waited until we owned about 17 units in 8 buildings as a regular old ordinary partnership.  When I created the entity (an s-corp), I had to sell the properties from the partnership to the s-corp entity costing me over $10k in Realty Transfer Tax (I understand PA is one of the worst states in the union for this with the tax rate at 2% of market value or sales contract, whichever is higher).  I also incurred legal fees and title insurance, plus filing fees at the courthouse....

All just to sell properties from a version of ME to another version of ME.

(But Remember, when you create a legal entity, it really is not YOU anymore.  It is like having a baby... it grows up.  It looks like you, acts like you, even does what you tell it to do...  Until one day it gets so big that it starts listening to what others tell it to do; such as HP, or McDonalds, or Home Depot, or Dell - get the point?  I hope you have that much success.)

There are plenty of good books in the biz section of your fave bookstore or go public at library if you are feeling cheap.  Study up.  Prepare your notes.  Become an expert.  Ask around here. Then ask the real experts (not here) - the ones you pay that are beholden to you in your state.

Christian Malesic · Answer

From a tax point of view, both have income flow thru the entity to the owners.  Thus, the entity itself is not taxable, except in odd situations and depending on state laws.

From a liability point of view, both take the liability off of you personally AS LONG AS YOU FOLLOW THE RULES.  This means, in sophomoric terms, if there is a slip and fall at one of your properties, the best lawyer in the world can take your biz and properties for all their worth, but he can not touch your jet ski, home, car, savings account, etc.  We could go on for pages here, as this is the topic of a major portion of many college courses entitled Business Law or the Legal Environment of Business, or such.  In a nutshell, we must treat the business as a business.  Have a Board of Directors that has real meetings and shareholders meeting for the corp., take notes, publish minutes, treat owners as owners not as employees (although they may be that as well).

Accountants for the REI biz, generally see them as 6 of one, half a dozen of the other.  Lawyers often the same, but ever so slightly prefer the LLC.

That said, I chose the S-Corp.  Why?  For me it was because I own another S-Corp and am familiar with the rules and the methods of keeping the corporate veil from being pierced.  I did not want to learn a new game, even though they are very similar.

As always with these things consult your attorney and your accountant.  I actually spoke with both by phone on the subject, prepared my questions & comments, then had a pow-wow with both at the same time in the same room to hash it all out.  It the end, they just provided pro & cons.  I had to decide what things I cared to protect the most and how I want to operate.  Then I made the decision.

Steve Chenoweth · Answer

Very helpful! Thanks a lot!

Account Closed · Answer

Keep the various elements logically distinct when you work the options.

1. Corporate tax benefits are few unless you have a full blown C corp. At the same time the C corp is bad for assets that rise in value and which are held long term.

2. Liability protection comes from having the property owned by someone other than yourself. It really is a transfer of the exposure. Unless you are graduating with significant assets having a property in your name vs. a company is not all that different. In both cases there is little to lose. Keep this in mind as you do not want to create lawyers that serve little benefit.

3. Financing will be tough with any structure. Likely you will need to finance things in your own name rather than the company until the company is established.

4. You can use the entity as a way to clearly organize the interests and responsibilities of the people who have a stake. Partners, employees, etc.

5. Remember liability insurance.

6. Few people that I have spoken to have used an LLP structure. Check with the state to see if there are any restrictions on what sort of businesses can use an LLP. Even if you can use an LLP figure out why that is superior to an LLC or other entity. LLPs were first established for partnerships (lawyers, accountants, etc) where they provide personal service but wanted to contain the liability.

7. Match the entity chosen to the business plan. If you are doing short term deals then there are few long term tax advantages. More business deductions can be good (medical, dental, vision, car, etc). LLC is different from a C in that way. Pension details can change also.

Bottom line is to pick something you understand, focus on making money and follow the rules when it comes to how you operate any entity. Run it incorrectly and you defeat the liability protection.

Note that you as individuals can still have liability if you are the people doing the work and making the decisions. Speak with a lawyer to understand what is important in terms of policies and procedures vs. just the entity choice.