As I move to start buying and renting properties, I need to get a legal framework underway to protect my (ass)ets. In America, anyone can sue you for practically anything. Moving into having renters in properties I own will open me up to a lot of potential liability.
- A person falls in the shower and injures themselves
- A person claims that the carpet in a home is making them sick
- Water leaks and ruins a person’s personal items, etc.
We already have an umbrella insurance policy that will help defend us in court and pay if we are successfully sued.
The umbrella policy is a great tool, but it doesn’t keep your personal assets out of the trial or case if you are sued. If I am sued, I want my personal assets such as my home, bank accounts, and cars protected from the lawsuit. To protect yourself, you have to have a legal framework that keeps your assets out of reach of those looking to take what you own.
I am taking my protection a step beyond an umbrella policy by setting up a company that will manage my rental properties and remove the personal from the work and liability.
The Limited Partnership is a great legal structure to use if you are going to buy and rent out multiple properties for three specific reasons. Limited Partnerships provide:
- Liability Protection
- Tax Efficiency
- Flexible Income Allocation
What is a Limited Partnership?
A Limited Partnership involves two or more partners, where the law requires at least one to accept liability for all the debts the partnership. That partner is called the “General Partner” and in my situation, the GP will not be a person, but rather a separate corporation.
The General Partner Corporation will have the authority to act for the partnership, for example, signing a contract. The GP will also contain a minimum of assets/capital which will protect you as the stockholder of the Limited Partnership.
Each partner in the Limited Partnership can be a shareholder in the GP corporation as well as being a limited partner.
Liability Protection of a Limited Partnership
When you form a limited partnership with a corporation as the General Partner, you as the individual Limited Partner will not be exposed to any personal liability beyond your capital contribution because the law holds the General Partner responsible for all third-party claims, unless the Limited Partner “acts in the capacity of a General Partner.”
What this means if I am sued for something happening at a rental property, the claimants in the suit cannot try to take my home, personal money in personal bank accounts, vehicles, etc. in their lawsuit. They can only sue the GP corporation.
This is a HUGE reason to go ahead and have this structure set up. It only takes one lawsuit to clean out all your property, money, and results of your hard work.
“Don’t let a trip on the stairs cost you your life’s savings!”
Significant Tax Savings
A Limited Partnership is more flexible than the common S-Corporation, which acts as a pass-through entity. Instead, the Limited Partnership allows you to eliminate self-employment taxes.
How much can you save??
Let’s say you are doing extremely well and making $200,000 on your 20 rental properties. You can avoid $19,500 you would normally have to pay in FICA and Medicare taxes.
If you get to the point where you hire independent contractors, they can become limited partners as well which would avoid their employment taxes as well. These new limited partners could have a stake in the business without giving them any vote or control of the company.
Flexible Income Allocation
If you have children or family members that the business may support from time to time, a Limited Partnership allows you to shift income to those individuals (family members) when appropriate who may not be in the same tax bracket as you.
Rather than provide them support using your “after tax” dollars, you can make them a limited partner and allocate them profit distributions from the Limited Partnership. Each limited partner would report the income on their personal tax return at their incremental tax rate.
An example could be if your daughter is in college and needs money for tuition. You could make her a limited partner of the company and allocate her profits – pre-tax and then she would only need to pay taxes at her tax bracket, which might be 0% or at least lower than your income tax bracket.
Setting up a Limited Partnership and LLCs is not free. You will have to pay different fees depending on your state. I am also paying an attorney who specializes in this type of work, contact information below! If you don’t want to hire my fabulous attorney, you can use Legal Zoom to set up the LP for you.
I’ve had the attorney move forward on setting up my Limited Partnership and first Limited Liability Company. It should take 2-3 weeks to get the paperwork filed and the structure of the business set up.
In exciting news, I’ve been asked to come along on a property search outing with two friends who are also doing real estate. I will report how it goes!