Figuring out how to start a real estate business can be challenging for a novice real estate investor. There are several aspects that you have to factor in and the learning curve can be quite steep when you don’t have the necessary prerequisites. Moreover, you will be faced with several critical decisions that will shape the future of your venture. A prime example of this is deciding between a real estate limited liability company and a real estate partnership. Keep reading as we compare partnership vs LLC and explore the benefits that each one offers to real estate investors.
What Does LLC Mean in Real Estate?
LLC stands for limited liability company. As the name suggests, the main purpose of this entity is to shield individuals from the risks of real estate investing, This includes protecting them from lawsuits and debt collection. In fact, members of a real estate LLC don’t have to dip into their own funds when it comes to paying settlements. Furthermore, this structure offers a number of benefits that extend beyond the legal aspects of business ownership. Here are some other pros that real estate investors can expect from an LLC structure.
- It offers a lot of flexibility when it comes to distributing profits between members
- An LLC for real estate provides privacy to the owners
- It allows members to include profits and losses from the LLC in their personal tax returns
- A single person can establish it
What Is a Real Estate Partnership Structure?
A partnership refers to an arrangement that ties several individuals into a single entity. Unlike an LLC, a real estate partnership agreement has to involve more than one person. The agreement sets the ownership share of each partner and outlines the financial and structural workings of the entity. Some of the information found in a partnership agreement includes how to distribute profits and losses, how to handle management and voting, and several guidelines for tax elections and partnership dissolution. Let’s take a look at some of the advantages of partnership structures.
- Partnerships are very easy to establish
- Managing a real estate partnership involves all members and not just a single individual
- Partnering up with individuals with complementary skills can prove extremely beneficial to your real estate business
- This structure offers a number of tax benefits
Now that we have gone over the definition of each structure, let’s delve into an in-depth partnership vs LLC comparison.
Partnership vs LLC: The Main Similarities
Despite the significant structural differences, both entities share a number of common features.
1- Registration
The registration of the two entities is fairly similar. In fact, each structure should be registered in the state where the entity operates and the entire process can be handled by a specialized agent.
2- Taxation
This is another point of similarity that becomes apparent when comparing partnership vs LLC. Both structures offer pass-through taxation. In other words, each member or partner pays taxes through their own personal tax returns. To get a better idea of how taxes affect the profitability of a real estate investment, give the Mashvisor investment property calculator a try.
Related: All You Need to Know About Investment Property Tax Deductions
3- Profit and loss distribution
The mechanisms by which profits and losses are distributed are near-identical. The profits that the real estate business generates are distributed directly to the members and partners.
Partnership vs LLC: The Main Differences
Like we stated earlier, there are significant functional and structural differences between the two entities.
1- Debt
The way debt is handled is one of the key differences between partnerships and LLC. In an LLC, debt is the responsibility of the entity itself whereas in a partnership, each individual is responsible for the debt of the real estate business.
Related: Is It Ok to Be in Debt While Investing in Real Estate?
2- Liability
An LLC protects its members from being personally liable in matters relating to lawsuits and settlements. In a partnership, however, each partner is liable for any irregularities that might occur when operating the business.
3- Tax options
While both entities offer pass-through taxation, an LLC offers other tax options to its members. For example, members of an LLC can opt for S corporation taxation.
After demystifying every aspect of these two structures, the next logical step is settling the partnership vs LLC debate.
Partnership vs LLC: What Is the Ideal Structure for Real Estate Investment?
Anyone looking to invest in the housing market will have to pick between establishing an LLC and forming a partnership. We believe that an LLC is more suited to the needs of real estate investors. The points discussed below should be enough to answer the question “Why form an LLC for real estate? “.
1- Transferring investment property is more cost-effective with an LLC
Operating a real estate business often involves the transfer of investment properties between different entities as well as to the personal use of the members. The advantage of using an LLC is that such transactions don’t have any tax consequences. This sets the LLC apart from a number of other structures that impose certain taxes on asset transfer.
2- An LLC protects your personal assets from liability
Real estate investments come with a host of legal and financial risks. Landlords will often find themselves dealing with problematic tenants that resort to legal action over slight grievances. Additionally, even guests and trespassers can take you to court over minor or completely fabricated issues. Having an LLC structure will help protect your personal assets and finances by limiting the liability to the LLC’s assets.
Related: The Most Common Reasons for Lawsuits Between Landlord and Tenant
3- The management structure of LLCs is ideal for real estate
Regardless of the type of real estate venture that you’re undertaking, the flexibility of the LLC makes it perfectly suited to your needs. For example, delegating property management responsibilities to other members is a simple and quick process. This is especially useful when you are dealing with a multifaceted sector like real estate. Another aspect where the LLC structure comes in handy is the flexible way in which you can distribute profits. Unlike other structures, an LLC allows you to reward members by distributing cash flow in a way that is not restricted by their pro-rata ownership stake.
The Verdict
Partnership vs LLC is an important decision that every real estate investor has to make. We believe that the arguments we presented above make a strong case for LLC being the ideal structure. If you are still uncertain about where you lie in the partnership vs LLC debate, you can always consult with a legal expert to get an idea of what would suit your real estate business best.
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