Best Rental Property Ownership (LLC, Corporation, Individual, Limited Partnership, General Partnership or Other)

This particular article of the Rental Property Tax Guide focuses on the different types of entities for rental property ownership. As outlined below, different types of entities have different advantages and disadvantages. However, the general goal in each case is to limit your liability and protect your property from unsecured creditors.

Individual Ownership

This is the most common and simplest method of ownership and occurs when you purchase the rental property in your own name. This includes owning the property with your spouse, or as joint tenants or tenants in common with someone else. The advantage is that this is simple, straightforward, and does not require the filing of any complicated paperwork or filing fees. The major disadvantage to this type of ownership is that your creditors may be able to force a sale of the rental property if they receive a court judgment against you, or compel you into involuntary bankruptcy.

Legal Entity Ownership

Legal entities include general partnerships, limited partnerships, limited liability companies, and corporations. The differences between the entities are important and outlined below. The major advantage to entity ownership is that your personal creditors cannot force a sale of the rental, since you do not own it. The only type of entity that does not require registration with the Secretary of State is the general partnership. For tax purposes, the type of entity chosen does not matter a whole lot because in most cases, rental income “passes through” from the entity and is taxed on your personal tax return (but see the cautionary note under corporations). See the article titled “Documents which Are Mandatory for Reporting Leasing Activity,” included in this Guide, for more on how rental income is taxed.

General partnership. A partnership is an association of two or more people to carry on as co-owners a business for profit. In a general partnership, each partner has equal management rights, but is personally liable for the debts of the partnership. Thus, a general partnership is generally not recommended.

Limited partnership. A limited partnership is tricky because it requires at least one general partner and one limited partner. The limited partner is not personally liable for the debts of the partnership, but also has no management rights. The general partner has sole management rights, and personal liability for the debts of the partnership. This arrangement is also generally not recommended.

Limited liability partnership/company. A limited liability partnership and a limited liability company are very similar entities, both providing for limited liability to the partners/members. This means that you are not personally liable for the entity’s debts, unless the debt stems from your own wrongdoing. This type of ownership is preferable because of limited liability and there are fewer formalities to observe than with corporations.

Corporations. Corporations allow for perpetual existence and limited liability. However, they also require the observance of certain formalities in order to keep the limited liability shield. In the absence of these formalities, a court may “pierce the corporate veil” and hold you personally liable. For this reason, LLPs and LLCs are generally more desirable for your purposes. Furthermore, for tax purposes, corporations are split into “S” corporations and “C” corporations. If the corporation is taxed as a “C” corporation, it will pay tax on the rental income, and then you will pay tax again when the corporation pays you dividends. You should avoid this “double taxation” trap.

  • To form any of the entities discussed below, the applicable registration form and fee must be filed with the Washington Secretary of State’s office. The forms can be found on the WA Secretary of State’s website.
  • Always consult an attorney or CPA before establishing an entity and transferring ownership of your rental property to it. This Guide is not meant to be comprehensive and requires the care of a qualified professional.

CPA in Shoreline+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

Deductible Rental Property Costs: Insurance, Cleaning/Maintenance, and Repairs

Since you now are leasing your property to obtain income, it’s very important that you make sure specific fees and expert services are adequately arranged and reported for IRS uses. We will take a look at some of these expenses.

Insurance

Similar to most premiums, it’s usually prepaid upfront for a certain period of time. An illustration here might be: you obtained insurance coverage with this particular rental property on March 2012 for $1200. The coverage duration is from April 2012 to March 31, 2013. Since the policy time period will exceed the present tax year, you should allocate the insurance premiums pertinent to this current tax year only and then bring forward the balance for the upcoming reporting period. This means that $900 (9 months April to Dec 2012) or $100 per month of eligible rental utilization would be your tax deductible premium.

Take note that some insurance companies routinely bundle premium plans among business and personal clients for a discount charge. Just the business rental property pertinent part will be deductible. The personal and non-business related utilization could be allowable with your individual income tax return. You should include Title Insurance within the Cost Basis of the property, because it is not an applicable expenditure.

Cleaning and Maintenance

The daily maintenance of the rental property is an allowed expense granted it is for commonly used places and day to day cleaning. These types of expenditures are also confined to the days that are allowable rental property days and not personal use days. Many property owners have contracts with local professional services to keep up the rental property on an ongoing basis to be sure it is in working and functional order. This could include such services as cleaning windows, dusting, cleaning home appliances and upkeep. Structural repairs and alterations are not allowed, so will have to be listed in the rental property’s Cost Basis.

Repairs

From time to time, there will probably be some sort of necessity to fix a home appliance, touch up a little repainting, or some endeavor which doesn’t demand serious reconstruction of the rental property structure. Depending on the leasing duration, you are able to deduct such necessary and ordinary expenses.

You should observe that these kinds of expenditures which are commonly allowable against the earnings of the property, and you mustn’t include the periods of time that are deemed personal times of use. Only those costs which are directly related to the approved leasing time period are permitted.

  • On the IRS’s website, you will find the various documents that you need. If you’d like additional information, view IRS Publication 527.

Huddleston CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

Allowable Automobile and Travel Expenses from Leased Premises

The specific use of your own private vehicle and other vehicles might be allowed as an expense depending on some specific criteria if typical and needed. If you are using your own personal cars to maintain and coordinate any rental residence, and even secure money from residents, you could be allowed to deduct these kinds of expenses. Because commuting to work is really a private cost, it isn’t permitted for deduction. Aside from that, you will not write off costs of commuting away from home to make improvements to residences. This is generally reclaimed with a cost recovery process, for example, depreciation. You will find 2 methods used to report these expenses:

Actual Expenses

The different expenditures resulting from having to travel out of the home in association with the leased residences will be documented with this solution. These kinds of costs need to be recorded and supported by invoices in line with IRS Publication 463, Chapter 5. A number of software applications are available through iPod, Quick Books, Mint, and others; however, you must still keep a concrete record to back up the write offs. It is important that this info be reported, together with important documents attached, on your Schedule C or Schedule E. For those who have multiple rental properties, your expenses should be allotted to the individual residence where expenses were incurred. Do not include things like any type of non-business use or any other sort of vehicle use aside from that specifically involving the rental property.

Mileage Method

According to this method, you’ll want to only write off your actual distance driven. You’d utilize the existing standard mileage taxation rate of $0.55.5 per mile if you drove twelve hundred miles in 2012.

Using local transport such as Zip Cars, metro bus services, and automobile rentals should have a direct connection to the real-estate and has to have paperwork to back this. If working with public transportation, it is encouraged that you carry a separate ticket card along with an individual business account for rental cars and Zip Cars showing how the utilization is exclusively business related.

Quick Note: You can obtain the different documents outlined in this information on the IRS’s webpage. For additional information, please consult IRS Publication 527.

Seattle CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

Resource for Business Valuations

The valuation of a business, business ownership interests or intangible assets may be performed for a wide variety of purposes including:

1)   Transactions such as acquisitions, mergers, buyouts, employee stock ownership plans, partner or shareholder buy-ins or buyouts, and stock redemptions.

2)   Litigation relating to matters such as marital dissolution, bankruptcy, contractual disputes, owner disputes, dissenting shareholder cases, employment disputes, and intellectual property disputes.

3)   Tax compliance such as corporate reorganizations, S corporation conversions, estate and gift tax, purchase price allocations, and charitable contributions.

4)   Tax planning for income estate and gift tax, and personal financial planning.

The Assumptions and Limiting Conditions Included in the Report Define the Business Valuation

The business valuation report will include a number of assumptions and limiting conditions under which the valuation was prepared. These assumptions and limiting conditions define the business valuation.

Conclusion of Value Limited to the Stated Purpose

1)   The conclusion of value is valid only for the stated purpose as of the date of the valuation.

2)   Stated purpose is very specific:

  1. A particular transaction:
    1. Acquisitions and mergers.
    2. Buyouts.
    3. Buy-ins.
  2. Litigation:
    1. Marital dissolution.
    2. Bankruptcy.
    3. Contractual disputes.
  3. Tax compliance:
    1. S corporation conversions.
    2. Estate and gift tax returns.
    3. Purchase price allocations
    4. Charitable contributions.
  4. Tax planning:
    1. Income tax.
    2. Estate and gift tax.
  5. Personal financial planning.

Reliance on Financial Statements and Other Information

1)   Financial statements and other related information are provided by the business or its representatives to the firm performing the valuation.

2)   These financial statements and other related information are accepted without any verification as fully and correctly reflecting the subject company’s business conditions and operating results.

3)   The firm performing the valuation will not have audited, reviewed, or compiled the financial information provided to them.

Public Information and Industry and Statistical Information

1)   The firm performing the valuation obtains public information and industry and statistical information from sources that it believes to be reliable.

2)   No representations as to the completeness or accuracy of the public information and industry and statistical information are made by the firm performing the valuation.

3)   No procedures have been performed by the firm performing the valuation to corroborate the public information and industry and statistical information.

Achievability of Forecasted Results

1)   Forecasts are frequently used in the calculation of value.

2)   A forecast is a prediction or estimate of some future event or trend.

3)   The firm performing the valuation provides no assurance as to the achievability of any forecasted results.

4)   Events and circumstances frequently do not occur as expected and differences between actual and expected results may be significant.

5)   Achievement of forecasted results depends on the actions, plans, and assumptions of management.

Management Expertise and Effectiveness

1)   The conclusion of value is based on the assumption that the current level of management expertise and effectiveness would continue to be maintained.

2)   The conclusion of value also assumes that the character and integrity of the subject business would not be significantly changed by any sale, reorganization, or exchange of the business, or by the diminution of the owners’ participation.

Use of the Valuation Report

1)   The valuation report and conclusion of value are for the exclusive use of the subject business or its representatives for the sole and specific purposes as noted in the report.

2)   The valuation report is not authorized to be used for any other purpose other than as noted in the report.

3)   The valuation report is not authorized to not be used by any other party, other than the subject business or its representatives, for any purpose.

4)   The report and conclusion of value are not intended to be investment advice in any manner. The conclusion of value represents the considered opinion for the firm performing the valuation, based on information provided by the subject company and other sources.

Dissemination to the Public

1)   No part of the valuation report it intended to be disseminated to the public by any means of communication. Any exception to this limitation would require the prior written consent and approval of the firm performing the valuation.

2)   Dissemination to the public would include such communications as advertising media, public relations, news media, sales media, mail, and direct transmittal.

Testimony or Attendance in Court

1)   Future services with respect to the subject matter of the valuation report, such as providing testimony or attendance in court, are not required of the firm performing the valuation.

2)   Additional services from the firm performing the valuation, such as providing testimony or attendance in court, would be available upon request and by separate arrangement.

Environmental Issues

1)   The firm performing the valuation is not an environmental consultant or auditor, and bears no responsibility for any actual or potential environmental liabilities.

2)   Those persons who need to know whether any actual or potential environmental liabilities exist, or the scope and effect of such liabilities on the value of the subject company, should obtain a professional environmental assessment.

Reliance on Environmental Reports

1)   In the case of reports provided by the subject company, or by an environmental consultant working for the subject company, of any present or future liability relating to environmental matters, for inclusion in the valuation report and conclusion of value, the firm performing the valuation may rely on those environmental reports without verification.

2)   The firm performing the valuation offers no warranty or representation as to the accuracy or completeness of any such environmental reports.

Americans With Disabilities Act

1)   The firm performing the valuation does not provide a compliance survey or analysis to determine compliance with the Americans with Disabilities Act of 1990.

2)   The valuation will not consider the effect, if any, of noncompliance with the Americans with Disabilities Act of 1990.

Future Legislation

1)   The firm performing the valuation makes no determination as to the possible effect on the subject business due to future Federal, state, or local legislation.

2)   The valuation would not consider the effect, if any, of any future Federal, state, or local legislation.

Prospective Financial Information

1)   Any prospective financial information provided by the subject company has not been examined or compiled by the firm performing the valuation.

2)   The firm performing the valuation does not express an opinion or other form of assurance on the prospective financial information or the related assumptions.

3)   Usually there will be differences between prospective financial information and actual results because events and circumstances frequently do not occur as expected. These differences may be significant.

The Valuation Engagement

Summary


This is an engagement to estimate value in which a valuation analyst determines an estimate of the value of a subject interest by performing appropriate valuation procedures, and is free to apply the valuation approaches and methods they deem appropriate in the circumstances. The valuation analyst expresses the results of the valuation engagement as a conclusion of value, which may be either a single amount or a range of amounts.

Standard of Value

The standard of value used is “fair market value”. Fair market value is the price, in terms of cash or equivalent, that a buyer could reasonably be expected to pay, and a seller could reasonably be expected to accept, if the business were exposed for sale on the open market for a reasonable period of time, with both buyer and seller being in possession of the pertinent facts and neither being under any compulsion to act.

Asset Approach

1)   The asset approach is generally considered to yield the minimum benchmark of value for an operating enterprise. The most common methods within this approach are net asset value and liquidation value.

2)   Net asset value represents net equity of the business after assets and liabilities have been adjusted to their fair market values, assuming a hypothetical sale of its net assets as part of a going concern.

3)   The liquidation value of the business represents the present value of the estimated net proceeds from liquidating the company’s assets in a quick and orderly piecemeal sale and paying off its liabilities.

Income Approach

1)   The income approach serves to estimate value by considering the income (benefits) generated by an asset over a period of time. This approach is based on the fundamental valuation principle that the value of a business is equal to the present worth of the future benefits of ownership. The term income does not necessarily refer to income in the accounting sense but to future benefits accruing to the owner. The most common methods under this approach are capitalization of earnings and discounted future earnings.

2)   Under the capitalization of earnings method, normalized historic earnings are capitalized at a rate that reflects the risk inherent in the expected future growth in those earnings.

3)   The discounted future earnings method discounts projected future earnings back to present value at a rate that reflects the risk inherent in the projected earnings.

Market Approach

1)   The market approach compares the subject company to the prices of similar companies operating in the same industry that are either publicly traded or, if privately-owned, have been sold recently.

2)   A common problem for privately owned businesses is a lack of publicly available comparable data.


  • Visit our Seattle or Bellevue business valuation sites for more information on Business Valuations from our experienced team of business professionals.