Entity Choice for Holding Real Estate in Pennsylvania

Everyone agrees that the average landlord or real estate developer is well-advised to hold real estate in a legal entity. The benefits of limited liability are too obvious to discuss. However, the question of what limited liability entity to hold the entity in is a little more complicated: what to use, a corporation, a limited partnership or a limited liability company?

We are usually warned never to say “never”; however, it seems safe to say that no one should put real estate into a corporation. Almost intuitively, clients know that a C-Corp with its double taxation at the corporate and shareholder level is a bad choice. Moreover, if appreciated real estate is distributed to C-Corp shareholders, the C-Corp recognizes a gain at the corporate level (as though a sale occurred) and the shareholders are taxed on the distribution. This is an obviously painful outcome. The C-Corp’s slightly friendlier sibling, the S-Corp, provides relief for the double taxation problem, but it has its own specific problem as a vehicle for holding real estate. Generally, the S-Corp shareholder does not get basis from third party loans, including any mortgage loan used to acquire the real estate. This lack of basis can limit any losses that a shareholder would otherwise be able to take, will create a tax for the shareholder if the corporation refinances and distributes the loan proceeds, and can be an expensive problem when the corporation is ultimately dissolved.

This leaves (at least for the average real estate holder) the choice of a limited partnership or a limited liability company. Until recently, a limited liability company was rarely used to hold 100% of the equity in Pennsylvania real estate. That structure had the potential to expose the taxpayer to Pennsylvania capital stock tax. Instead a hybrid entity consisting of a limited partnership (holding the bulk of the equity) with a limited liability company as general partner (holding a small portion of the equity) was used. This method was successful in reducing or eliminating the capital stock tax. The trade-off however, was the inconvenience that comes with maintaining two entities and preparing two tax returns annually, even if no tax was due on them. Now, with the demise of the Pennsylvania capital stock tax, there is no reason to not hold real estate through a limited liability company. As a vehicle, the limited liability company provides limited liability to its owners, very little annual bookkeeping, and pass-through tax treatment for purposes of state and federal income tax. If there is more than one owner, such an entity requires an annual partnership tax return with income passed out to the owners. If only one owner, then for income tax purposes the entity is “disregarded,” which means no additional tax return is need on April 15 (only the taxpayers normal return is needed).

There is now a well-earned consensus that a limited liability company is, for the average landlord or developer, the best vehicle for holding real estate in Pennsylvania.

– Rod Fluck

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