To own real estate you must hold title, and the way you hold title affects how the ownership of a property can be transferred; how the property can be financed, improved or used as collateral, and it has tax implications. Methods of holding title include limited liability companies (LLCs) and limited liability partnerships (LLPs), partnerships, S-corporations and C-corporations, tenants in common, joint tenancy, community property, community property with the right of survivorship, sole ownership, a married person as sole and separate property and trusts.
Before I go any further, I must start with a massive disclaimer: I am not an attorney or an accountant. People’s decisions on how to hold title impacts their income tax, capital gains tax, property tax, inheritance tax and legal positions and more. This column will not provide instructions on how to hold title, but rather arm you with questions to take to your accountant and attorney. Every situation comes with its own complications that MUST be addressed by those professionals.
LLCs and LLPs are typically used when unrelated parties acquire title to income-producing property but there are advantages to related parties taking title this was as well. The parties probably have an existing business or personal relationship, and they know (and trust) each other. The advantages of LLCs and LLPs include a buffer from legal liability, and someone with whom to share responsibility. The disadvantages include the setup and administrative costs, and while the federal government treats LLCs and LLPs as non-existent for income tax purposes, the State of California does not. Therefore, you owe state income tax on income produced by the property.
S-corps and C-corps are similar to LLCs and LLPs in that they provide protection from liability, for everything from slips and falls that occur on the property to the discovery of a toxic waste dump located under the main building. S-corps and C-corps are more burdensome and expensive to administer, but useful if an existing corporation chooses to purchase a property where it will operate a business. C-corps are unlikely for small investors because of the high cost of compliance with regulations and because they are not exempt from state or federal income taxes. S-corps and C-corps generally only hold title if they already exist. You wouldn’t create these types of corporations simply to hold title to real estate. There are extensive down sides to these forms of ownership and you MUST talk to your attorney before you go this route.
Whether we’re talking about LLCs, LLPs, S-corps, or C-corps—even if the company or partnership already exists—the smart choice is often to own a property as an individual and lease it back to the company. This avoids unnecessary tax burdens and paperwork, as well as retaining depreciation for your personal income tax return at a better rate than the corporate return would allow. While these corporate structures can shield property owners from some liability, if owners don’t follow the corporate rules to the letter, a claimant can pierce the corporate veil and come after the owners’ personal assets.
I once had a tenant with a corporation who co-mingled personal and corporate funds. He allowed his corporation to go bankrupt, but was a personally wealthy individual. Because he didn’t follow the rules, I was able to pierce the corporate veil and collect $45,000 in “uncollectable” rent. So a word to the wise, if you want to take advantage of the liability protection, know the rules and follow them.
Next week, I’ll detail a few more ways to hold title. Remember, I am not an attorney or accountant. Do not think that by reading this column you now have all the information you need to make what usually amounts to complex and legally binding decisions with significant tax implications.
If you have questions about real estate or property management, please contact me at firstname.lastname@example.org or visit www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you’re a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 35 years.