Posted almost 13 years ago

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.


Comments (29)

  1. Some really great info, but I'm also overwhelmed now.  I'm a newbie here and will have to continue to read/research to see what works best.  I want to start wholesaling, but I don't know if I need/should have a LLC first.  I'm not sure why I would need an LLC to wholesale, but I also didn't think I needed an entity to do real estate until I researched that as well.  I'll keep reading and researching on BP.  Thanks BP (Josh) because I've learned a ton in just the last hour on this forum.  Much respect.


  2. Greg,

    Thanks for the info, very informative. The different between the two have  been a debate with a lot of investors for years. This is great info for the all investors, great blog.


  3. Useful information, thank you. Under what scenario would an LP structure be appropriate?  


  4. Speaking of LLCs, my attorney wants to charge me $1500 to transfer title of my investment property to an LLC.

    However, Is it foolish of me to do it on my own on the NJ State website and send over the papers to the state for filing, or am i missing an important step?


    1. @Dennis Cuocci, how is your property titled now?  When did you buy it and how what is the buyer on the current deed?  

      Gerald


  5. I am a lawyer licensed in TX. I'm not your lawyer though. 

    This article is a poor analysis of LPs versus LLCs. Especially regarding depreciation. A limited partner absolutely can realize depreciation provided the limited partner has positive basis. LPs are traditionally sold to investors for their depreciation advantages in syndication. 

    LPs are ideal for real estate investing in many scenarios, particularly when bringing in outside money. However they need a separate limited liability entity such as an LLC to be the Genera partner, so they have more expensive formation costs and have two tax returns at the minimum of the GP is not a disregarded entity. 

    While I do primarily form LLCs in my practice,  LPs serve an important role in many real estate company structures. 

    Do yourself a favor and get your entity structure advice from an actual lawyer in your jurisdiction instead of from an Internet post. 


  6. Is there a limit on the number of properties or number of partners within an LLC? Also, if I create an LLC in one state, can I buy and add properties in a different state under the same LLC? Thank you all in advance.


  7. For some of my rentals we have setup a layered system where the properties are owned by LPs and the General Partner of those is an LLC that manages the properties. We only put a few places in each LP then form new ones with the same LLC as GP on all of them. I'd think this would eliminate whatever tax issues would arise from material participation as the limited partners and the members/managers in the LLC, at this point at least, are all the same.


  8. Great post!


  9. LPs get depreciation to the extent they have tax basis in their equity investment. I would suggest readers get some tax advice prior to relying on much of the above.


  10. LPs get depreciation to the extent they have tax basis in their equity investment. I would suggest readers get some tax advice prior to relying on much of the above.



  11. Does a LLC offer the same liability protection across state lines? I have a LLC owning a rental in one state, but buying a rental in another state. Can I put the new property in same LLC, or do I need to set up a new LLC?


  12. Great post! Thanks for sharing.


  13. 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.


  14. 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. 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.


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


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


  18. Thanks for the advice. Something to think about


  19. 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.


  20. Very good post.


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


  22. This speaks of LLC vs LP for rental property


  23. 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.


  24. Great info...I always used LLCs...now I'm glad I did. Thanks again!


  25. Thank you for sharing this great information!


  26. 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.


  27. 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.