Many real estate investors form their own limited liability corporation (LLC,) limited liability partnership (LLP,) and some consider forming a general partnership. It is worth knowing the differences, so you make the decisions that are right for you, your business, and your business partners. Different business entities impact both California State and Federal tax liability and other matters. They also affect how individuals who are involved in the business are viewed by California and federal law.
A California corporation is a legal entity which exists separately from its owners. It, therefore, continues to exist after owners cease their personal ownership. This separation limits owner liabilities to the amount invested in the corporation. Taxes are levied on both the corporation and the stockholders. Individuals who form a corporation must file Articles of Incorporation with California's Secretary of State.
Limited Liability Company (LLC)
An LLC limits its owner’s liability at a personal level from being pursued to settle corporate debts or to personally meet judgments made against the LLC unless personal and company funds are co-mingled or if a member agrees to underwrite company debt. Apart from limiting personal liability, being an LLC stockholder means that company tax losses can be reported on a personal tax return to reduce some personal tax liabilities.
The company must have a business name (including either "Limited Liability Company," "LLC," or "L.L.C.") The name should be unique and should not be a look-alike of an existing company name. This is to avoid confusion in the general public about its ownership or purpose. The name may not include certain words; bank, insurance company are two simple examples.
An LLC must produce an Operating Agreement. The agreement is, in effect, a contract between the owners which states:
Why the business exists
How it will be run and managed
How operating profits and losses will be handled
How any new members will be added?
California law requires that appropriate records are maintained. These include:
A copy of the Articles of Organization, Operating Agreement, and member names
Accounting, tax, and member contribution records
Six years of financial statements
Limited Partnership (LP)
An LP offers some limited liability for some partners. An LP must have at least one general partner who controls the running of the partnership business, and at least one limited partner whose personal liability is determined by the amount of involvement or participation they have in the business. The general partner's personal liability is unlimited as far as meeting partnership debts or other obligations.
General Partnership (GP)
A GP must have at least two partners, all of whom share unlimited liability for business debts and obligations. Profits are taxed as personal income.
Limited Liability Partnership (LLP)
From a real estate point of view, an LLP would only be appropriate if it focuses on land surveying. LLPs must maintain certain levels of insurance to satisfy California law.
Real estate investors who decide to form a business entity may be best advised to create a Limited Liability Company for maximum personal liability protection. Please take legal advice before forming an LLC, and please don’t hesitate to contact us to discuss your borrowing needs.