Key Takeaways

  • LLCs offer greater flexibility, liability protection, and favorable tax treatment for real estate investors.
  • LLPs and LPs can be useful in certain partnership models but carry more risk for general partners.
  • LLCs are more commonly chosen for real estate investments due to ease of management, privacy, and fewer regulatory hurdles.
  • LLPs require at least two partners and may not be as advantageous for sole investors.
  • Using a corporation as a general partner in an LP or LLP can limit liability exposure.
  • LLCs may provide more advantageous outcomes for rental properties, while S corporations can reduce self-employment tax for active property flipping.

LLC vs partnership for real estate is a valid concern for business owners wanting to protect themselves from vulnerability. By using a business structure for real estate investment, owners increase their chances of avoiding personal liability for accidents that may take place on the property.

About LLC vs Partnerships for Real Estate

Liability

Owning property, whether as an individual or in a general partnership, results in unlimited liability. This means the property is vulnerable to guests, tenants, and even trespassers in some cases to file a lawsuit for imagined grievances. If they win the case, your home, personal possessions, and bank account are at risk to satisfy a judgment. When a limited liability company (LLC) or limited partnership (LP) is involved, the liability is limited to the extent of the assets of the LP or LLC.

Key Differences Between LLC and LLP for Real Estate

While both LLCs and LLPs provide limited liability protections, their application in real estate varies significantly.

LLCs for Real Estate:

  • Ideal for holding rental or investment properties due to asset protection and flexible tax treatment.
  • Offers protection for all members (owners) from personal liability for debts and lawsuits related to the property.
  • Can be owned by a single individual (in most states), making it suitable for solo investors.
  • Management can be customized, allowing either direct member involvement or designated managers.

LLPs for Real Estate:

  • Typically used by professional services firms but can be structured for co-investment in real estate.
  • Require at least two partners; not suitable for sole investors.
  • Only protect limited partners from liability—general partners may still be exposed unless additional protections (e.g., LLC as a general partner) are used.
  • LLPs are less common in real estate compared to LLCs due to less favorable formation rules and exposure to liability.

When comparing LLC vs LLP for real estate, the LLC usually emerges as the more practical and protective structure, particularly for long-term asset holding and rental income.

Beneficial Management Structure

Limited Liability Company

An LLC or LP may provide the management structure that suits your needs. With an LLC, you have access to a flexible schedule that allows two options: member-management or manager-managed. All members have limited liability, and in some states, an LLC can be formed by one person only.

Limited Partnership

A limited partnership does not have the option of formation by one person. It requires at least one general partner and one limited partner. The general partner is held personally liable. This can be circumvented by forming an LLC or a corporation to serve as the general partner. Two additional reasons for using an LLC or LP for real estate investments are to gain benefits from estate planning and gifting opportunities when available.

Privacy and Public Record Considerations

One often-overlooked aspect of choosing between an LLC and an LLP is privacy. LLCs generally offer better privacy protections, especially in states that allow anonymous ownership filings. Real estate investors who want to limit exposure of their names in public records can often use nominee services or trusts in conjunction with LLCs.

LLPs, on the other hand, often require partners' names to be filed publicly, which may reduce privacy for investors wanting discretion in their holdings.

Reduced Taxation on Appreciated Property

Although a corporation may seem like the best option for a business owner, when it involves real estate investments, it is not the recommended choice. When real estate is held in either an LLC or LP and the property is sold to a third party, there are tax benefits to be gained.

Unlike a C corporation, which has double taxation, LLCs, LPs, and S corporations are allowed to use a flow-through tax treatment. This means they are only taxed one time. Also, appreciation on the property will result in less tax when it's held by an LLC or LP.

Raising Capital Through LLC vs LLP

When raising capital for real estate deals, both LLCs and LLPs can accommodate investor contributions. However, LLCs offer more flexibility in structuring equity ownership and profit distribution:

  • LLCs allow disproportionate allocations of profit, which is ideal for syndications and investor agreements.
  • LLPs typically require more uniform treatment among partners, limiting creative deal structures.

Moreover, LLCs are often preferred by private lenders and institutional investors due to their familiarity and straightforward compliance processes.

Property Transfers

If an owner chooses to transfer the property to your personal use or to an LLC member of LP partner, there are benefits. For example, this would not result in any tax consequences. Even though limited liability is available with other business entities, there are tax repercussions. This makes an LP or LLC a better option.

State-Specific Rules and Limitations

Real estate investors should be aware that the laws governing LLCs and LLPs can vary widely by state. For example:

  • Some states do not recognize LLPs for real estate investment purposes.
  • States like California impose a minimum franchise tax on LLCs regardless of income.
  • Florida and Delaware are popular LLC jurisdictions for real estate investors due to favorable asset protection statutes and ease of formation.

Consulting a local attorney is critical when choosing between LLC vs LLP for real estate to ensure compliance with state-specific requirements.

Depreciation

When a rental property is owned, depreciation is one of the benefits. This is due to the cost of the property being amortized. This can take place over the course of the loan or the period it is owned. General partners would not be allowed to take advantage of the expense of depreciation if the general partner participated in the operation or management of the rental property.

Creditor Protection and Bankruptcy

LLCs often provide stronger protections against creditors. In most jurisdictions, creditors of an LLC member can only access the member’s interest in distributions through a charging order—they cannot force the sale of LLC-owned real estate. This is an important layer of defense.

In contrast, LLPs and general partnerships may not offer the same protection. Creditors could potentially reach the partnership’s assets if the partnership is not properly structured or if general partners are personally liable.

Self-Employment Tax

When the objective of a piece of existing real estate is to buy, remodel, and sell within one year, this can be considered an active trade or business by the Internal Revenue Service. Unlike a passive income from a rental property, income generated from an active trade or business is subject to self-employment tax. This is a 15 percent tax to cover Social Security and Medicare by employed individuals.

To reduce self-employment tax to a minimum, an S corporation is the best choice of business entity. This is because the rules for an S corporation allow the business owner to draw a reasonable salary that's subject to Medicare and Social Security.

Once those figures are deducted, the remaining profit is taken out as distributions and is not subject to self-employment taxes. In contrast, all of an LLC's business income under the same or similar circumstances will be subject to self-employment taxes. Using an S corporation structure versus an LLC structure can result in significant savings for the business owner.

When a property is held as a cash flow investment, an LLC structure is generally the choice. This is due to:

  • Flexibility.
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  • Distribution rules being more liberal for an LLC. LLC distributions are on an at-cost basis.
  • The fact that members file a K-1 Form and pay taxes on profits as if were income.

When dealing with investment real estate property, speak with an attorney specializing in this area. Contracts and statutes vary from state to state and change often.

Frequently Asked Questions

What is better for real estate, an LLC or LLP? An LLC is generally better for real estate due to its limited liability, flexible tax treatment, and greater control over management structure.

Can an LLC own real estate in multiple states? Yes, but the LLC must register as a foreign entity in each state where it owns property.

Why would someone choose an LLP over an LLC? An LLP might be chosen when multiple professional partners are involved and want equal say in operations. It's less common in real estate investing.

Are there tax advantages to using an LLC over an LLP for real estate? LLCs typically allow more flexibility in allocating profits and losses, and they can elect different tax treatments, including partnership or S corporation status.

Can I convert my LLP to an LLC? Yes, conversion is often possible, but the process and requirements vary by state and may have tax implications.

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