By Bill Falor, Attorney
Noland, Hamerly, Etienne & Hoss
As published in the Salinas Valley Business Journal, September 2023
Let’s say you and a few friends pooled your money and bought a rental property. You’re excited – it’s an apartment complex with long-term tenants who pay their rent on time and don’t make a fuss. You have a joint bank account you use to deposit rent checks and pay expenses (everyone trusts each other) and you’ve secured a solid umbrella policy with a reputable insurer.
But you’ve heard horror stories about insurance companies denying claims and something bugs you – what happens if someone gets injured at the property, insurance denies or only partially covers the claim, and the injured person goes after you and your friends for the rest? Can they really take your personal assets not tied to the property, e.g., your house and car and life insurance policy?
Unfortunately, the answer is yes – they can. Without proper liability protection, you and your friends are exposed to personal losses if insurance is insufficient in the event of a claim. So how can you better protect yourself? You guessed it – a business entity that holds the property. But, you can’t just use any business entity – in fact, most are a bad idea because they merely add more complexity to your operation without addressing your underlying business needs.
Here’s a quick primer on your options and why, if you find yourself in the above fact pattern, you might consider using (or not using) a certain entity:
- General Partnership. With this entity, all partners are completely liable for all debts of the partnership. For the above fact pattern, this should be avoided as it does not provide liability protection.
- Limited Partnership. This entity provides liability protection for the limited partners, but there must be a general partner who bears the risk. For the above fact pattern, unless one of the owners is willing to do so, this too should be avoided.
- Corporation. This entity has liability protection for the shareholders, but your CPA will tell you to avoid it because of double taxation (for “C”-corps) or other tax implications beyond the scope of this article (for “S”-corps). In short, for these reasons and others, we would not recommend using a corporation for the above fact pattern.
- Limited Liability Company (LLC). This is your best option for the above fact pattern – you have liability protection as the company is a separate entity from its owners, you don’t have double taxation, and you don’t have the other tax implications faced by S-corps.
To be clear, the above analysis is not at all exhaustive with regard to the above fact pattern as it focuses only on liability protection and, to a lesser extent, state/federal income taxes. That is, issues such as property taxes, estate planning, and administrative expenses and processes should be further explored with qualified counsel, and it should be noted that an LLC has an annual minimum franchise tax of $800 and also a gross receipts tax if your annual revenue exceeds $250,000. That being said, although these other issues certainly should be explored for the above fact pattern and others like it, we typically find that the benefits provided by the appropriate entity (not least of which being peace of mind) outweigh the issues they may cause.
Obviously, the above fact pattern presents a hypothetical scenario; should you have any questions or need advice on your specific situation, the attorneys at Noland, Hamerly, Etienne & Hoss can help.
This article is intended to address topics of general interest and should not be construed as legal advice.
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