Different types of entities have advantages and disadvantages. However, the general goal in each case is to limit your liability and protect your property from unsecured creditors.
To form any entity (S Corp, C Corp, LLC, sole proprietorship, etc.), the registration form and fee must be filed with the Washington Secretary of State’s office. The forms can be found at: https://www.sos.wa.gov/corps/registration_forms.aspx
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.
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 Necessary Tax Forms for Reporting Rental 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 Or 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.