Maybe you can help answer a question for this newbie in TX. We have just bought a property (it is in my name and so is the note). I purchased $1M umbrella liability policy for now.
Here is what we have done based on the CPA’s advice. We have formed an LLC with my spouse as the General Partner and also formed a Limited Partnership with the aforementioned LLC as the General Partner. The plan is to transfer title of the recently purchased property to the LP using a General Warranty Deed. Does this make sense?
I am trying to figure out if this is the right approach from asset protectiion (we have joint assets outside of RE)/legal perspective and I have no clue what this does from a tax perspective. Your advice would be much appreciated.
Keith-- I thought it would be better to not start a new thread since it was a question for McWagner but now I know better so I will start a new thread in the future.
Also a correction to my statement.
My spouse is the not the GP in the LLC but a Manager/President. The LLC is in turn the GP in the LP.
what is the purpose of the LLC? exactly why did he recommend this?
are you going to buy more properties?
how much time are you expecting to work the business?
is this a rental or flip?
who are the other partners in the LP
it sounds like the objective is to have the limited partner shelter income from SE tax. this only works if the limited partner spends under 500 hours a year running the business. that’s under 10 hours a week. not much if you’re doing the work yourself or managing multiple properties. you could claim that you were working for the LLC/GP when you were hanging that drywall, and not working as a limited partner. but that’s pretty thin when dealing with closely held companies.
if the purpose of the LLC as GP is something else, then I would question the need for the LP. Since the LLC is pretty flexible with taxation, you could probably avoid the need for the LP. Note that by taxing the LLC as S-Corp and paying a reasonable salary, LLC income may avoid SE tax anyway.
an additional benefit is that the LLC is the “manager” of the property, so that you personally are not. Note that this will still not protect you from negligence attacks (you, as a person, regardless of which company you ‘work’ for, didn’t repair that loose board). If this is the only reason for the LLC GP, I’d skip the LP and save the hassle.
yeah, I’d like to know exactly why he recommended that.
I will spend less than 500 hours but my spouse will definitely spend more than 500 hours. Our goal is to accumulate properties for long haul, rental income and build equity (appreciation is gravy). So I fully expect to purchase more and multiple properties including Multi-Family.
I own another business and have high income. We started real estate to look for tax savings. Our main concern was protecting ourselves against liability where our other assets may be jeopordized. The CPA set this up for us and said this was the best setup from a legal perspective (maybe even tax I am not sure). I talked briefly to a top attorney I know who is himself a RE investor and he confirmed that ths setup was the “traditional” setup he used.
I am now thoroughly confused ???why we need both and what protection we have from liability once we roll the property over into the LP.
So it seems you are saying that from a liability perspective having the property in a LP and working as a manager of the LLC doesn’t insulate us personally
and from a tax prespective this setup will not fly (in terms of avoiding SE tax). I wish I had looked into this more closely before we spent the 1K for the setup :-[
If your only real estate business will be managing your own rental property, then there is no SE tax on rental property income.
When you establish a business entity to “manage” the properties held by another entity, then the management fees the company charges become active income for your management company AND self-employment income taxes come into play.
Your entity structure may be creating more of a tax burden for you that can be avoided with a single LLC entity that owns and operates the rentals. You have to ask why you need this entity structure when asset protection is available with a simpler structure and you have to ask why you need to convert passive income to active income with the entity structure the CPA is proposing.
Perhaps there are other issues with your outside businesses that affect the grand design. Perhaps there are other activities that you plan to conduct within this entity structure that you have not told us. Your CPA should clarify all this for you.
No, I have specified everything we have planned thus far for the RE business. No grand design. My other biz is totally unrelated and will necessarily be kept separate (it is the bread and butter).
I am really concerned that I have unnecessarily complicated things by creating the LP not to mention the $750 fees for forming it. I don’t understand enough about LP and LLC and furthermore how they are applied to the RE biz so I am at a loss. Alls I’m trying to do is to provide liability protection (RE rental) and asset protection, and to reduce taxes from my main other business. You and Mcwagner have pointed out a few disadvantages of my entity structures so it seems like if my CPA cannot explain to me how the LP is needed to attain my goals, I need to tell my CPA to fold the LP and then I need to transfer the property from my name to the LLC. Then my spouse manages the properties as a manager of the LLC. Does this approach seem reasonable?
Better to have a sunk cost of $750 than to lose more in taxes over the years.
I would hope that the CPA has a “big picture” that includes all your businesses, your personal holdings, your marginal tax bracket, and the strength of your financial statement. His proposal for this entity structure for your real estate activity needs to fit into the asset protection plan and the estate planning that has already been done for you.
If you don’t understand that there may be a “grand design”, then you need to have more conversations with your CPA. If there really is no all encompassing asset protection and estate plan, then you need to bring other professionals into your team.
If you need the services of an estate planning professional and a financial planner, I can give you the name of someone in the Dallas area that I have consulted in the past. Her fees aren’t cheap, but if your net worth exceeds $2MM, a consultation may be worthwhile if all you really do is get a second opinion.