Selecting the Best Entity for Real Estate Investment

This article provides a quick summary of the best entities for real estate investment. There are three types of entities most commonly used to own real estate: Limited Liability Company, S Corporation and Limited Partnership.

1. Limited Liability Company for Long Term Investors

The Limited Liability Company (known as LLC) is the best entity for most real estate and mortgage investors who "buy and hold" their investments. When you buy and hold real estate it is considered a capital asset. The primary goal for "buy and hold" investors is to achieve rental income and long term capital appreciation. In most states, including Florida, the ownership of real estate does not constitute the transaction of business. For that reason, a Delaware LLC formed for the sole purpose of owning real estate is not required to register as a foreign LLC in the state where the real estate is located.

2. S Corporation for Short Term Investors

Some real estate investors engage in a business practice commonly called flipping real estate. This means the investors "buy and sell" real estate with the goal of turning a quick profit. When real estate is flipped it is considered inventory and the investor is considered a "dealer." A real estate dealer cannot take advantage of the following tax benefits that are available to buy and hold real estate investors:

  • Capital gain tax rate
  • Depreciation deductions
  • Installment sales method for recognizing gain
  • Tax free like-kind exchange under Code Section 1031

Real estate investors who flip real estate should form an S corporation (or LLC taxable as an S corporation). This allows the dealer to avoid self-employment/social security tax on a portion of the profit earned from flipping real estate.

3. Limited Partnership

The Florida intangible tax has been repealed effective January 1, 2007. Under prior law, real estate investors could avoid the Florida intangible tax by forming a limited partnership to buy real estate. (In Florida, "Ltd." is a common name ending for a limited partnership.) Prior to the repeal, the Florida intangible tax was calculated by this formula:

Annual Florida Intangible Tax = .001 x Value of Intangible Asset

An ownership interest in an entity is considered an intangible asset. An ownership interest in a limited partnership, however, was exempt from the Florida intangible tax.

Since a limited partnership can be very expensive to form, this type of entity was most often used to buy real estate with a purchase price of $10 million or more, assuming an 80% loan to value ratio. With that loan to value ratio, the equity value is $2 million. (This article ignores the valuation discounts that may apply to limited partners.) Since the ownership interest in a limited partnership was exempt from the Florida intangible tax, the partners could avoid the $2,000 intangible tax that would be owed if the same real estate were owned instead through an LLC or S corporation.

While there may be some estate planning benefits to forming a limited partnership, the same benefits can be accomplished by forming a limited liability company that issues nonvoting units with restrictions that are equivalent to those on limited partners in a limited partnership. In most cases, it is better to form a limited liability company instead of a limited partnership since the Florida intangible tax has been repealed and the Florida filing fee to form a limited liability company is significantly less than the Florida filing fee to form a limited partnership. If you decide to form a limited partnership, it is important that you form a separate entity to be the general partner to avoid personal liability for individuals who manage the limited partnership.

4. Multiple Entities

Real estate investors who plan to flip some real estate and keep other real estate longer term, should form at least one S corporation (or LLC taxable as an S corporation) to flip real estate and at least one Delaware LLC to own real estate longer term. Real estate investors should never mix in the same entity "buy and flip real estate" with "buy and hold real estate."