Let’s launch off by looking at the various entity selection types available. Each has benefits and drawbacks. As a rule of thumb, look to protect your property from unsecured creditors and limit your liability. So let’s lay out the list and see what we’ve got here…
Note: When forming an entity, you will have to visit Business Entity Registration to register.
Note: This guide will not serve to replace the qualified council of a CPA or attorney. You should seek qualified professional help when establishing an entity and shifting ownership of a rental property.
This is the most common and simplest method of ownership and occurs when you purchase the rental property in your name. This includes owning the property with your spouse, or as joint tenants or tenants in common with someone else. The big benefit is that this is straightforward and simple, for one it does not require you to file any complicated paperwork or filing fees. The major disadvantage to this form of ownership is that your creditors might be able to force a sale of the rental property if they attain a court judgment against you, or compel you into an involuntary bankruptcy.
Legal Entity Ownership
General partnerships, limited liability companies, and corporations are all legal entities. The differences between these entities are important and outlined below. The main advantage to entity ownership is that your personal creditors won’t be able to force a sale of the rental, given that you don’t own it. The only type of entity that does not require registration with the Secretary of State is the general partnership. As far as taxes are concerned, the type of entity chosen doesn’t matter too much because in most cases, income from the rental property “passes through” from the entity and is taxed on your personal tax return (but do note the cautionary note under corporations). Cover the article entitled Necessary Tax Forms for Reporting Rental Activity, included in this Guide, for more on just 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 the debts of the partnership. And as a consequence a general partnership is usually not preferred.
Limited partnership. This entity is more complex than a general partnership because it requires both a limited partner and one general partner. The general partner has sole management rights, and also personal liability for any debts. Whereas, the limited partner isn’t personally liable for debts of the partnership and at the same time has no management rights.
Limited liability partnership/company (LLPs or LLCs). A limited liability partnership and a limited liability company are rather similar entity types, both provide for limited liability to partners/members. This means you are not personally liable for the entity’s debts, unless the debt stems from your own wrongdoing. This kind of ownership is usually preferable because of limited liability plus there are fewer formalities that require observance than with corporations.
Corporations. This type of ownership offers limited liability and allows for perpetual existence. Although this mode of ownership requires the upholding of specified formalities that allow you to maintain this limited liability status. So under this reasoning that LLPs or LLCs are generally speaking more suiting for your purposes. Also worth noting is that corporations fall under one of two categories: c-corp or s-corp. When a corporation is taxed as a c-corporation, it will pay tax on rental income, and then you will pay tax (again) when the c-corporation pays dividends. And it’s preferred to side-step the double-taxation trap whenever it is possible.
Please visit our Rental Property Tax Guide. It’s a collection of articles written to help landlords navigate the tax regulations and laws that pertain to them.
Seattle Tax CPA John Huddleston has written extensively on several tax related topics. He graduated in 1999 from the University of Washington School of Law with a Masters in Tax Law. Ten years prior, he obtained his juris doctorate from the same institution, and was a member of the Washington Law Review Executive Board.