Choice and Structure of Real Estate Entities in Colorado

Choice and Structure of Real Estate Entities in Colorado

© 2018 Lance S. Davidson All rights reserved.

Choice of Entity & Tax Considerations. In Colorado, the typical types of entities used to hold real estate are generally:

  1. the general partnership, and its offspring, the Limited Liability Partnership and the Limited Partnership Association;
  2. the limited partnership, and its offspring, the Limited Liability Limited Partnership;
  3. the trust,
  4. the corporation, and
  5. the limited liability company.

Title 7 – Corporations and Associations of the Colorado Revised Statutes is codified at C.R.S. §§ 7-1-101 to § 7-137-301.

  1. General Partnership.

1.1.1 General Partnerships Generally. The statutory authority for a general partnership [GP] is at Articles 60 and 64 of Title 7, Colorado Revised Statutes, § 7-60-101 to § 7-60-154, and § 7-64-101 to § 7-64-107. Note that two sets of statutes govern general partnerships in Colorado. The Uniform Partnership Law Act, C.R.S. § 7-60-101, et seq.; and the Colorado Uniform Partnership Act (1997), C.R.S. § 7-64-101, et seq. The older Uniform Partnership Law Act governs general partnerships formed before January 1, 1998; the 1997 Colorado Uniform Partnership Act governs partnerships formed on January 1, 1998 or thereafter, and pre-1998 partnerships that specifically elect to be covered by it.  A partnership may be implied statutorily. See C.R.S. § 7-64-202; C.R.S. § 7-60-107. Unless formed specifically as a limited partnership, naming specifically one or more limited partners, a partnership defaults to a general partnership.

A general partnership comprises “the association of two or more persons to carry on, as co-owners, a business for profit.” See C.R.S. § 7-64-202; C.R.S. § 7-60-106. Each partner in a general partnership is jointly and severally liable for all debts and obligations of the partnership. See C.R.S. § 7-64-306; C.R.S. § 7-60-115.

1.1.2 Liability. In a general partnership, all partners are fully, completely, totally liable for the debts and obligations of the general partnership. Not only that, in a general partnership each partner is jointly and severally liable for all debts and obligations of the partnership. See C.R.S. § 7-64-306; C.R.S. § 7-60-115. So creditors of a general partnership can pursue any general partner’s assets to satisfy the unpaid debts and obligations of the general partnership.

1.1.3 Fiduciary Duties. Partners in a general partnership owe fiduciary duties to the partnership. The standard of care of a fiduciary embraces the duty of care, duty of loyalty, duty of good faith, duty of confidentiality, duty of disclosure, duty of accounting and duty of prudence. Statutorily, “[e]very partner shall account to the partnership for any benefit and hold as trustee for it any profits derived by such partner without the consent of the other partners from any transaction connected with the formation, conduct, or liquidation of the partnership or from any use by such partner of its property. C.R.S. § 7-60-121. This statute even stretches to include the personal representative of the last surviving partner winding up the general partnership’s affairs.  C.R.S. § 7-60-121 (2). Partners’ duty of care is not limited to the partnership but also embraces other partners. “A partner owes to the partnership and the other partners a duty of care in the conduct and winding up of the partnership business which shall be limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law.” C.R.S. § 7-64-404 (2).

1.1.4 Taxation. Partners in a general partnership are taxed at the individual taxpayer level despite the general partnership being a separate, legally distinct entity. Thus, the general partnerships profits and losses ‘flow through’ to the partners and are reported on their individual tax returns. The partnership reports its income on an information return (Form 1065). It also reports to each individual partner his/her share of items of partnership income, gains, losses, deductions, and credits (on Schedule K-1, Form 1065). Schedule K-1 identifies separately the partner’s share of the partnership’s taxable operations. The general partners are also subject to self-employment taxes, due to their characterization, for tax purposes, as self-employed.

1.2. Limited Liability Partnership.

1.2.1 Limited Liability Partnerships Generally. Part 10 of Article 64 of Title 7, Colorado Revised Statutes contains the statutory authority for governing a limited partnership [LLP] in Colorado, specifically C.R.S. § 7-64-1001 through C.R.S. § 7-64-1010. Limited Liability Partnership is a General Partnership that is registered so that the partners are not personally liable for the debts and obligations of the general partnership. LLPs are formed by registering with the Colorado Secretary of State. As with a general partnership, all partners have a statutory right to participate in the management of the business. Also, as with a general partnership, unless otherwise provided in the partnership agreement, in an LLP all profits and losses are shared equally among the partners, and decision-making in an LLP is by majority vote of the partners. The withdrawal or termination [‘disassociation’] of a partner will not dissolve the partnership unless the disassociation results in the partnership having only a single partner.

1.2.2 Liability. As already noted, a limited liability partnership is a creature of statute to provide limited liability to each partner for the partnership’s debts and obligations. LLPs were originally envisioned to be used for businesses that expose partners to significant liability by virtue of the profession in which they participate (doctors, lawyers, accountants, etc.). LLPs shield partners from liability created by their partners, so that a partner generally won’t be held accountable for other partners’ debts, obligations, or negligence. A partner in an LLP is personally liable only for his or her own negligence (or of someone working under their direct supervision). In a general partnership, each partner is liable for the debts and obligations of the business, as well as the torts of other partners. Because a limited liability partnership limits liability, unlike a general partnership, a limited liability partnership by statute is subject to the theory of ‘piercing the corporate veil’ so that individual partners may be held responsible for partnership obligations and liabilities. Failure to observe management formalities or requirements, however, is not per se grounds for imposing personal liability on partners. See C.R.S. § 7-64-1009.

1.2.3 Taxation. LLPs in Colorado may choose either to be taxed as a partnership with the partners accounting for the profits and losses individually, or as a corporation where the business pays its own taxes.

1.3 Limited Partnership Association (LPA).

1.3.1 Limited Partnerships Associations Generally. Article 63 of Title 7, Colorado Revised Statutes contains the statutory authority for governing a limited partnership association [LPA] in Colorado, specifically C.R.S. § 7-63-101 through § 7-63-116. A limited partnership association, infrequently used in Colorado, is a hybrid of a corporation and a partnership. An LPA is formed by filing Articles of Association with the Secretary of State. C.R. S. § 7-63-104. Owners of an LPA are known as ‘members’; strangely enough, an LPA may have only one member. Unlike LLPs, LPAs do not end upon the resignation, death, incompetence or bankruptcy of a member, unless otherwise agreed. C.R.S. § 7-63-116.

1.3.2 Liability. A member of an LPA is not liable for any debt, obligation or liability of the LPA. Moreover, the LPA is not even required to be in business but may be formed for any lawful activity. Either its members or designated manager(s) may operate the limited partnership association.

1.3.3 Taxation. The LPA is taxed like a partnership rather than as a corporation.

2. Limited Partnership.

2.1.1 Limited Partnerships Generally. Articles 61 and 62 of Title 7, Colorado Revised Statutes contain the statutory authority for governing limited partnerships in Colorado, specifically C.R.S. § 7-61-101 through § 7-61-130 and C.R.S. § 7-62-101 through § 7-62-1105. Limited partnerships were the favored entity of choice in Colorado and throughout the country until the widespread of acceptance of limited liability companies. Before Colorado adopted its LLC statute in 1990 [Cf. Arizona in 1992], the limited partnership (“LP”) was the entity of choice to hold real estate and the corporation was the entity of choice to operate a business. The primary reason of the demise of limited partnerships was that the general partner of a limited partnership–and there had to be at least one general partner–had general liability. That is, the personal assets–all of them unless otherwise protected—of the general partner[s] were subject to claims and liens of creditors for unpaid debts and obligations of the limited partnerships. Weighing the value of control versus the general liability exposure as a general partner in limited partnerships, syndicators and other general partners in the business of real estate opted instead for the ease and limited liability of limited liability companies.

Unlike a general partnership which has two or more persons conducting a business with general liability, a Colorado limited partnership must have one or more general partners and one or more limited partners.  See C.R.S. § 7-62-101.

Also, unlike a general partnership, a limited partnership to be properly formed requires a certificate of limited partnership to be filed with the Colorado Secretary of State. C.R.S. § 7-62-201.

2.1.2 Liability. As referenced earlier, the general partners in a limited partnership are personally liable for the debts and obligations of the partnership. See C.R.S. § 7-62-403. A central distinction of the limited partnership compared to the general partnership, however, is that the limited partner[s] will not be personally liable for the debts and obligations of the partnership. In other words, the liability of the limited partners for debts and obligations of the limited partnership is limited to the amount of their capital contributions.  The foregoing is conditioned upon two caveats: that the partnership has been properly formed in compliance with Colorado law and the limited partner does not participate in the control of the business. C.R.S. § 7-62-303. If so participating in the control of the business, the limited partner is liable only to persons who transact business or conduct activities with the limited partnership reasonably believing, based upon the limited partner’s conduct, that the limited partner is a general partner at the time such liability is incurred, regardless of the limited partnership certificate. C.R.S. § 7-62-303(1)(a).

2.1.3 Fiduciary Duties. Colorado’s Uniform Partnership Act (“UPA”) will govern in the absence of a formal partnership agreement.  Among other things, the UPA provides that partners hold fiduciary duties to one another. They must account to the partnership, must refrain from conflicts of interest, and must refrain from self-dealing to the disadvantage of other partners. See C.R.S. § 7-64-401 and C.R.S. § 7-64-404.

2.1.4 Taxation.  General and limited partners in a limited partnership are taxed at the individual level in a separate schedule to their personal tax returns, despite the partnership being a separate, legally distinct entity. Thus, the limited partnership’s profits and losses ‘flow through’ to the general and limited partners and are reported on their individual tax returns. The partnership reports its income on an information return (Form 1065). It also reports to each individual partner his/her share of items of partnership income, gains, losses, deductions, and credits (on Schedule K-1, Form 1065). The general partner(s) are also subject to self-employment taxes, due to their characterization, for tax purposes, as self-employed.

2.2 Limited Liability Limited Partnership.

2.2.1 Limited Liability Limited Partnerships Generally. Colorado’s Limited Liability Limited Partnership Act became law July 1, 1995. This Act permitted limited partnerships to register as limited liability partnerships with the Colorado Secretary of State. C.R.S. § 7-64-1002. While these entities are often restricted nationwide to businesses where all the owners belong to a single licensed profession, e.g. CPAs, attorneys, doctors, etc., Colorado has no such limitation. See C.R.S. § 7-64-1001 through C.R.S. § 7-64-1010. Only 10 or so states have statutes for these new entities. A limited liability limited partnership is registered as a limited liability limited partnership under C.R.S. § 7-60-144 or C.R.S. § 7-64-1002.

2.2.2  Liability. In a traditional limited partnership, the general partners are jointly and severally liable for its debts and obligations, but the limited partners are not liable for those debts and obligations beyond the amount of their capital contributions. In an LLLP, once properly registered under state law, the general partners enjoy limited liability for the debts and obligations of the limited partnership that arise during the period that the LLLP election is in place. So the general partners of LLLPs once registered enjoy the same liability protection granted general partners in a registered LLP—their liability exposure is limited to their capital investment in the limited partnership. Still, contrary provisions in the partnership agreement can override this limitation of general partner liability provided in the Act. In Colorado, a limited partner of a limited partnership properly registered as a limited liability limited partnership is not liable for the partnership’s obligations while the LLLP is registered. C.R.S. § 7-62-303(1)(b). A limited partner in an LLLP faces only the loss of his or her capital investment in the entity, but no further liability absent personal professional misconduct. A benefit of the limited liability limited partnership is that a partner in such a professional partnership will not be held accountable for another partner’s debts, obligations, or negligence. New investors can be brought in to contribute to the business without being liable for other partners’ debts or obligations. Another benefit is to eliminate the need to create and use a limited liability entity for the general partner, which was the legal ‘fix’ to bypass general partner liability for years. Still, the assets of the limited partnership remain subject to the claims of creditors even if registered as a LLLP, so the “interest in the partnership” of each partner remains at risk. A limited liability partnership by statute is subject to the theory of ‘piercing the corporate veil’ so general partners may be held responsible for partnership obligations and liabilities. Failure to observe management formalities or requirements, however, is not per se grounds for imposing personal liability on them. See C.R.S. § 7-64-1009.

2.2.3 Taxation.  General and limited partners in a limited liability limited partnership in Colorado may choose either to be taxed as a partnership with the partners accounting for the profits and losses individually, or as a corporation where the business pays its own taxes. Unclear is whether a LLLP will be treated in bankruptcy as a partnership as well as a corporation despite selecting tax treatment as one or the other.

  1. Trust.

3.1 Trusts Generally. Effective January 1, 2019, Colorado created in April, 2018 a new Colorado uniform trust code to address trust administration that had been generally within the purview of the probate code. The new code, which includes statutes in Title 15, the Colorado Probate Code, and especially Article 16 for Trust Administration, is at C.R.S. § 15-16-101 through § 15-16-930 includes provisions concerning: judicial proceedings; representation; creation, validity, modification, and termination of trusts; duties and powers of trustees; and liabilities of trustees and rights of persons dealing with trustees.

To form a trust, the trust creator (also called trustor or settlor) names a trustee to hold legal title to property conveyed by the trustor to the trustee for the benefit of one or more beneficiaries designated by the trustor. A Colorado trust need not file any formation documents with any Colorado governmental agency, pay any formation filing fees or publish any documents in a newspaper.  The trustor may be the trustee and a beneficiary. A trustee of a trust owes fiduciary duties to all the beneficiaries of the trust. Property must be conveyed or assigned to the trustee of the trust before the trustee can manage the property according to the trustor’s instructions. While trusts may be created by an oral agreement, but if a trust involves assets with more than nominal value, the trust should be in writing. Trusts may be revocable, irrevocable, simple or complex, but most trusts are revocable when first created. A revocable trust is a trust that can be amended or terminated at any time by the trustor. Every trust involving valuable property should be evidenced by a good written trust agreement that instructs the trustee on exactly what to do with the trust property.

Colorado–and California, Missouri, and Nevada–have trust laws that allow trustees to hold title to property for a trust in its own name (caveat–a trust, not a land trust). CRS § 38-30-108 provides that, for all instruments conveying real estate to a grantee in a representative capacity, a trustee must name the beneficiary of the trust and define the trust agreement. But Colorado law expressly allows real property to be titled in the name of the trust itself (without naming the trustee in the deed). C.R.S. § 38-30-108.5 (1). C.R.S. § 38-30-108.5 (2), however, requires that a Statement of Authority is also recorded in the real estate records to show the existence of the trust and the identity of the trustee(s). A new Statement of Authority should be recorded before a conveyance of trust property if there is a change of trustee.

Colorado has a statute that requires a trustee to act reasonably in exercising any of its powers. C.R.S. § 15-1-804(1). Note that a reasonableness standard is a more stringent standard than a good faith or lack of bad faith standard See, e.g., Marshall v. Grauberger, 796 P.2d 34 (Colo. App. 1990) in which the court imposed a reasonableness standard on a trustee with extensive discretion.

3.2 Land Trusts Generally. The primary purpose for a land trust is to hide the acquisition, ownership, or disposition of real estate. The land trust is also widely used to hold title to agricultural land for farming families seeking to pass their property to succeeding generations without risk of partition by dissident heirs. Legal title to the property in the trust is held by the trustee and not the beneficiaries, so it is not subject to a partition proceeding. Only six states (Illinois, Indiana, South Dakota, Florida, Hawaii, and Virginia) have a land trust statute. A land trust could be formed in other states, but those states’ statutes may not defer to the Illinois Land Trust statutes to determine validity and case law absent a choice of law provision that would bind the beneficiary, trustee, and the property located there. Only Louisiana prohibits land be held in a trust. A land trust is a real property title-holding vehicle, a trust agreement under which the beneficiary directs the trustee in all matters affecting title to the trust property.

A land trust agreement is not recorded; while the deed conveying property to the trust is recorded, it does not identify the trustee and beneficiary. The ownership of the property simply assigns the beneficial interest under the trust. The interest of the land trust beneficiary is considered personal property, similar to owning a partnership interest or corporate stock. This is important in avoiding probate of out-of-state property and in asset-protection planning. The land trust agreement almost always names a corporate fiduciary as the trustee to avoid human ‘foibles’ such as death, disinterest, relocations, etc.; successors to the beneficiary in case the beneficiary dies during the term of the trust; and a specific term, which may be extended.

3.3 Liability in Land Trusts. Courts deciding land trust cases uniformly hold that while the beneficiary is empowered to direct the trustee on all matters affecting the real property, no agency relationship is created and the trustee acts only as a principal and not as an agent. The beneficiary remains liable for trust property operations and in the trust agreement the beneficiary also holds the trustee free from liability. Land trusts are not different from regular trusts in creditor suits. So a revocable trust in which a settlor retains the power to revoke a trust, the settlor’s creditors can reach the assets of the trust. While this suggests all land trusts should be irrevocable, most land trusts are revocable; they are primarily tools for estate-planning and avoiding creditors ab initio. And a court would likely find that if a land trust was set up with intent to commit fraud, it is invalid, and that the property is therefore available to creditors.

3.4 Taxation of a Land Trust. A properly structured land trust should be classified for income-tax purposes as a grantor trust per Internal Revenue Code §677. If so, all income and deductions flow through to the beneficiary(ies) in amounts proportionate to their respective interests in the trust estate. The ultimate tax treatment is determined by the terms of the partnership agreement if the beneficiary is a partnership, and by the governing documents of a corporation if the beneficiary is a corporation.

  1. Corporation.

4.1 Corporations Generally. Articles 1 through 52 of Title 7, Colorado Revised Statutes contain the statutory authority for governing corporations in Colorado, specifically C.R.S. § 7-1-101 through § 7-52-106. Colorado corporations have been registered with the Colorado Secretary of State since 1864. A corporation is formed by filing articles of incorporation, as it is a separate and distinct legal entity apart from its owners, the shareholders. While the shareholders own a corporation, the Board of Directors is responsible for managing the corporation, with the assistance of the corporation’s officers. The shareholders elect the members of the Board of Directors at the annual meeting of shareholders. A corporation is operated day-to-day by its officers (CEO, President, Treasurer, Secretary, etc.), who are appointed by the board of directors, and they report to and serve under the guidance of the board. Decision-making authority rests with the board of directors, except that major extraordinary decisions, e.g., mergers, acquisitions, amendment of Bylaws, stock issuance, require shareholder ratification. See C.R.S. §§ 7-106-102, 7-110-201, 7-111-101, 7-112-101, 7-112-102, etc. Colorado corporations (and other Colorado business entities) must have a registered agent legally appointed on the company’s formation documents to accept service of process on behalf of the company if sued. In addition to the Articles of Incorporation, shareholders, officers and directors will be subject also to its by-laws and other binding instruments; shareholders may also be subject to any shareholder agreements.

4.2 Operations. After forming the corporation, the directors named in the Articles prudently should have an organizational meeting to adopt resolutions approving the corporation’s bylaws, naming the officers of the corporation, and authorizing the issuance of stock to the stockholders, the form of the stock certificate, and the opening of corporate bank accounts.  Colorado law requires that the shareholders hold an annual meeting, but directors should meet as often as necessary to manage the corporation and oversee the officers, [but not less than once a year]. See C.R.S. § 7-107-101. A single person may form a Colorado corporation and be its sole shareholder, officer and director. Meetings of shareholders and directors must be called by giving proper notice as set forth in the Bylaws of the corporation. Each meeting requires a quorum to be able to conduct a meeting and to approve any action. All meetings of directors and officers should be documented with written minutes duly signed by the authorized managers. As with limited liability companies [discussed below, but unlike general partnerships, trusts and sole proprietorships, corporations must file an annual report with the Colorado Secretary of State together with a $10 fee to maintain current information about the corporation. Entities are not required to file the names and addresses of shareholders, directors or officers with the Secretary of State’s office, so no updating of this information is required.

4.3 Liability. The engine for the growth of corporations, and arguably for the growth economically of the United States, is that a corporation will afford ordinarily its shareholders and managers limited liability. That is, shareholders, officers and directors of a corporation are not generally liable for the corporation’s obligations and liabilities. There are exceptions to this general rule; for example, directors and officers may be liable for improper or illegal conduct. Shareholders are only liable for the obligations of the company up to their investment (provided that the corporation is following required corporate formalities). The legal concept “piercing the corporate veil” occurs when a court permits creditors to penetrate this corporate shield of limited liability and imposes general liability. Piercing the corporate veil may result from something as seemingly innocuous as not observing the formalities of operating in the corporate form. The risk of having the corporate veil pierced is why it is very important that corporations hold properly called and documented annual and special meetings of stockholders and directors and that they file their annual reports and pay the filing fee timely.

4.4 Corporation Types to Hold Real Estate. Two types of for-profit corporations generally hold real estate—a C corporation and an S corporation. The only significant differences between them are how they are treated for tax purposes, and that there are significant restrictions on the creation of an S Corp, e.g., the number of classes of stock it can issue and the number and type of shareholders it may have. A corporation is called a C corporation if it is taxed under Subchapter C of the Internal Revenue Code of 1986 or an S corporation if it is taxed under Subchapter S of the Internal Revenue Code. C corporations and S corporations are taxed differently for federal income tax purposes [discussed below], but structurally and for most other purposes, they are the same.

4.4.1 Different Federal Income Taxation Treatment for C and S Corporations. A corporation is a distinct taxpayer under federal income tax law that files its own federal income tax return [Form 1120]. A C corporation must pay at its corporate tax rate on taxable income, and its losses can only be offset by the corporation’s income. Profits, losses and other tax items of a C corporation are not passed through to its shareholders for them to use on their personal income tax returns.

4.4.2 Because a C corporation is subject to double taxation on income—at the corporate level and again at the individual [shareholder] level—Subchapter S corporations are an attractive alternative for corporate ownership of real estate and other purposes. For qualifying S corporations, there is ordinarily no tax at the corporate level, i.e., distributions are ‘passed through’ to the individual level and taxed at the shareholder’s marginal tax rate. An S corporation must file an in informational tax return on IRS Form 1120S to notify the IRS of its profits, losses and other tax significant items, despite not being a taxpaying entity for federal income tax purposes, it. See IRS Publication 542, Corporations.

4.4.3 An S corporation may not have more than 100 shareholders; spouses (and their estates) are treated as a single shareholder. [In contrast, there are no limits on the number of stockholders or the types of entities that can own stock of a C corporation.]  Shareholders may only be individuals, estates, exempt organizations described in Internal Revenue Code Sections 401(a) or 501(c)(3) or certain trusts described in Section 1361(c)(2)(A). The corporation must not have more than one class of stock. The corporation must have a tax year-end based on the calendar year unless a different year-end was approved by the IRS. A shareholder may not be a nonresident alien. All shareholders of an S corporation must have agreed on Form 2553, the form to elect subchapter S tax treatment within 75 days from the date of formation, to adopt S corporation status.

4.4.4 Except in limited instances [e.g., taxable recapture if the corporation used the LIFO inventory method the year before converting to S status, taxable recapture for any investment credit, tax net recognized built-in gain, taxable excess net passive income], the profits and losses of the S corporation are passed through pro rata to its shareholders based on each shareholder’s percentage ownership of stock for them to report tax on their personal returns.

5.1  Limited Liability Companies Generally. Limited liability companies (LLCs) in Colorado are governed by the Colorado Limited Liability Company Act in Article 80 of Title 7, C.R.S. § § 7-80-101 through § 7-80-109. An LLC is a corporate-partnership hybrid entity. As with a corporation, an LLC shields its owners (members) with limited liability and permits the separation of ownership from management; as with a partnership, it permits tax recognition of profits and losses to be passed through to the individual members and an operating agreement govern member-member and member-LLC relationships. The members may self-manage the LLC or appoint managers to run day-to-day operations. In a manager-managed LLC, a member has no authority to bind the LLC solely by virtue of membership in the LLC; similarly, a corporate shareholder has no authority to bind the corporation solely by virtue of being a shareholder. C.R.S. § 7-80-405(1). In a member-managed LLC–unless restricted by the Operating Agreement, outside the ordinary course of business, or dealing with a third party knowing same–each member has authority to bind the LLC in a transaction. C.R.S. § 7-80-405(2).

The LLC form of entity enjoys advantages over the other types of business entities. Overall, it has few legal formalities [no requirement for annual meetings and minutes]; it is cheap to form; it is inexpensive to operate; it is a good asset protection vehicle [see below]; and it offers multiple ways to be taxed at the federal level. A Colorado LLC is thus ordinarily the common choice of entity to hold real estate because there are fewer legal formalities. For-profit corporations, the typical alternative to an LLC for holding real estate, have more corporate formalities than an LLC: corporations must hold meetings of shareholders and of the board of directors at least annually, and the meetings of shareholders and the board of directors must be documented with minutes or resolutions. Unless a majority or unanimous consent, vote, or agreement of the members is required by statute, the operating agreement may grant to all or a stated group of the members the right to consent, vote, or agree, on a per capita or other basis, upon any matter. C.R.S. § 7-80-706(1).

5.2 Liability. Members and managers of limited liability companies are not liable under a judgment, decree, or order of a court, or in any other manner, for a debt, obligation, or liability of the limited liability company. C.R.S. § 7-80-705. Still, a judgment creditor may seek from a court of competent jurisdiction a charging order against a member’s membership interest for an adjudged debt. C.R.S. § 7-80-703. A charging order on the LLC is a court order that when and if any property including cash is to be distributed to the judgment debtor, the LLC instead must distribute the property to the judgment creditor. The judgment creditor has only the rights of an assignee or transferee of the membership interest and is subject to any applicable federal and state exemption laws. Ibid.

5.3 Comparing LLCs to Corporations and LLP and LLLPs. The significance of the distinction of formalities between an LLC and a corporation should not be lost; a corporation may be dissolved involuntarily by the Secretary of State if the annual meetings are not held and documented, or a creditor may ‘pierce the corporate veil’ and attach personal assets of the corporate shareholder[s] to satisfy the corporation’s liabilities and obligations. Once a business entity is administratively dissolved (not just a corporation, but a corporation is more vulnerable to involuntary dissolution due to noncompliance with formalities than other entities), it is prohibited by statute from engaging in any activities other than those necessary to liquidate its assets and wind up its affairs. Often an administratively dissolved business entity continues to operate as a going concern because the people who are acting on its behalf are unaware of its dissolution. If an administratively dissolved business entity continues doing business, however, the entity, and its owners and managers, can run into a variety of legal problems, including the people who act on its behalf may be held personally liable for debts or obligations incurred while dissolved; it may be unable to bring a lawsuit or proceeding; and actions it takes, other than those done to wind up its affairs, may be considered void or voidable. The owners effectively become common law general partners, with each liable for all the debts and obligations of the unincorporated business activity.

By comparison, the relatively new limited liability limited partnership entity which shields partners from another partner’s debts, obligations, or negligence may become more popular in the future. While members of an LLC are protected from any debt or liabilities of the business, members of an LLC are not protected from the liability of another member. So if an LLC member makes a legally actionable client error, for example, then the LLC and all its members can be held liable. By contrast, partners in an LLLP (or LLP) can be protected from the liability of another member.

5.4 Taxation. An LLC may be taxed at the  federal level as [1] a sole proprietorship [single-member LLC or two- members who are a husband and wife who own their interest as community property]; [2] a partnership [if there are at least two members] under subchapter K of the IRC; as a C corporation under subchapter C of the IRC; or as an S corporation [if in compliance with subchapter S of the IRC]. As with a corporation, an LLCs can be taxed under subchapter S or subchapter C of the Internal Revenue Code, but the selection of the method of taxation does not transmute the LLC into a corporation. Just as selection of subchapter S for a corporation does not affect its corporate status, an LLC remains an LLC.

6. Sole Proprietorships. Despite being a common, if not the most common, way to hold real estate, sole proprietorships are an atypical form that a real estate or corporate lawyer would advise the client to use to own and operate real estate.

6.1 Liability. The business and the owner are effectively indistinct, so the owner is personally liable for any business liabilities, obligations and debts. Not just the business’s assets but also the owner’s personal assets are at risk if the business fails or incurs more debt than it can pay in the ordinary course of business.

6.2 Taxation. Because the business is not a legally distinct entity from the business owner, the business entity is neither separately taxed nor files a separate tax return. Instead, sole proprietorships are taxed only at the individual taxpayer level. All income and losses from the business are reported, or ‘flow through,’ as personal income or losses onto the business owner’s tax return. Thus, revenues and expenses of the business are reported on Schedule C to the individual taxpayer’s tax return.

6.2.1 Because sole proprietorships are taxed at the individual level, owners, treated as self-employed, are consequently subject to pay self-employment taxes in addition to federal and state income taxes. Compare tax treatment of a sole proprietorship with an employee: [1] The sole proprietorship as employer is responsible for paying half of the employee’s Social Security and Medicare taxes. [2] Because in a sole proprietorship the owner is his or her own employer, however, the owner is subject to paying both halves of the employer’s Social Security and Medicare taxes.

 

The contents of this website are intended to convey general information only and not to provide legal, tax or financial advice or opinions. Information contained on this website should not be relied upon and we disclaim all liability in respect to actions taken or not taken based on any or all of the contents of this site to the fullest extent permitted by law.  An attorney should be contacted for advice on specific legal issues.

Reference:   National CLE Conference 2019; Business and Tax Law Strategic Planning:  Choice and Structure of Real Estate Entity © 2018 Lance S. Davidson All rights reserved.

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