Ownership of Rental Properties

This article of the Landlord’s Tax Guide (Guide) discusses the types of entities for the ownership of rental properties. You’ll see below different types of entities have their respective pluses and minuses. However, the general aim is to limit liability and protect your real estate from any unsecured creditors.

When forming an entity, you will have to go to SOS.WA.GOV to complete the registration.

Note: This tax guide wont serve to replace the expert council of a certified public accountant or tax attorney. You should seek qualified professional counsel when setting up an entity and transferring ownership of a rental property.

Individual Ownership

This is the simpler and more popular method of establishing ownership. This is when you purchase a rental property in your own name. The significant disadvantage of this type of ownership is that your creditors may be able to force a sale of the rental property if they receive court mandate against you, or they could potentially compel you into involuntary bankruptcy. A big plus to this form of ownership is that the process is simple, without complex forms or heavy filing fees.

Legal Entity Ownership

Legal entities include general partnerships, limited partnerships, limited liability companies, and corporations. The differences between these entities are important. We’ll outline them below. The major advantage to entity ownership is that your personal creditors won’t be able to force a sale of the rental property, because you do not own it. The general partnership is the only type of entity that does not require registration with the Secretary of State. As far as taxes are concerned, the type of entity chosen does not matter a tremendous amount because in most cases, rental income “passes through” from the entity and is taxed on your personal tax return (but do note the cautionary note under corporations). See the article entitled Necessary Tax Forms for Reporting Rental Activity, included in this tax guide for landlords, for more on how rental income is taxed.

General partnership. This form of ownership takes place when two or more persons co-own a business for profit. Now with this general partnership each partner has equal management privileges, but also each partner is personally liable for any incurring debts of the partnership. And as a consequence a general partnership is most often not preferred.

Limited partnership. The limited partnership is tricky considering the fact that this form of ownership requires one limited partner and at least one general partner. The limited partner isn’t personally liable for the debts resulting from the partnership, but also has no management rights. Now the general partner has sole management rights, and also personal liability for the debts resulting from the partnership. This arrangement also is usually not suggested.

Limited liability partnership/company (LLPs or LLCs). A limited liability company and a limited liability partnership are quite similar entities, both providing for limited liability to partners/members. This means that you will not be personally liable for the debts of the entity, except in cases when the debt stems from your own wrongdoing. This mode of ownership is often preferable because of limited liability and also there are fewer formalities that require observance than with corporations.

Corporations. Corporations enable limited liability and perpetual existence. And yet on the other hand, they necessitate the observance of certain formalities in order to retain the limited liability guard. Without these formalities, a court may “pierce the corporate veil” and hold you personally culpable. It is for this reason that LLCs and LLPs are frequently more desirable for your purposes. Furthermore, for tax purposes, corporations are split into “S” corporations and “C” corporations. When a corporation is taxed as a “C” corporation, it will pay tax on rental income, and then you will pay tax once more when the corporation pays you dividends. And you should steer clear of this “double taxation” snare.

Accountant +John Huddleston has written several articles on accounting and taxes. He is a graduate of Washington State University and the University of Washington School of Law.