LP – Limited Partnership
Asset Protection strategies for high-risk assets, such as short-term rentals (Airbnb’s and VRBO’s), should consider all possible entity structures available under the law to provide a comprehensive strategy for the most protection, ease of use and maintenance. One such entity that should be considered for maximum protection and maintenance is the Limited Partnership.
Limited Partnership (LP) entities can be an effective tool in asset protection for short-term rentals and other real estate investments in combination with a Limited Liability Company (LLC). As mentioned in our discussion with LLC’s, each short-term rental property or long-term rental property should be owned in its own individual LLC. However, the more real estate and other net worth you accumulate, the more inefficient and ineffective it is to use LLC’s exclusively as the primary method of asset protection. An effective strategy to consider is the use of a Limited Partnership as a holding company for all your real estate assets.
The concept of a partnership has been around since contract law has existed and there is a volume of settled case law regarding the valid use of a Limited Partnership for real estate and asset protection purposes. The basic structure of a Limited Partnership involves a General Partner and a Limited Partner. General partners are viewed under the law as being the controlling or “active” partner in the partnership and bear the responsibility for management and possible liability for actions under the law. Limited Partners are seen as non-active and not responsible for management or decision-making in the partnership. Many limited partners contribute capital to the partnership and are liable only for the amount contributed in the partnership arrangement.
Holding Company Strategies: Limited Partnership (LP) vs. Limited Liability Company (LLC)
After placing each short-term rental property in its own unique LLC, you must now decide what entity should be considered for your holding company. For example: what if you own a short-term rental in Texas, another in Oklahoma, and a final property in Arizona. Each short-term rental has been placed in its own unique LLC. How do we tie them together under single management? Let us first consider the use of an LLC.
By creating an LLC holding company to own your short-term rental LLC’s, you will face the same challenges and shortcomings as we discussed in our LLC discussion. One of the biggest differences between the use of an LLC or LP with a holding company is that LLCs only provide you protection to the extent your attorney drafts adequate charging order protections in your LLC entity. In other words, if your attorney fails to provide adequate protections in your charging orders, you will have an LLC that becomes an easy target for a lawsuit.
Additionally, it is important that your holding company not be a disregarded entity for tax purposes! If you set up a single member LLC, it will be treated as a disregarded entity – this is a red flag! An aggressive attorney filing a lawsuit against the actions arising out of your short-term rental property will argue a disregarded entity LLC was set up for a non-legitimate business purpose, thereby increasing the odds of piercing the veil of your LLC structure. Your holding company must maintain its legal identity separate from you and must file its own tax return.
In contrast, Limited Partnerships provide asset protection built-in because of the statutory provisions creating protection. By statute, Limited Partnerships have two classes of ownership: general partner and limited partner. The limited partner in an LP is always classified a non-controlling and non-liable party in a Limited Partnership. As such, you are not relying up on the charging order protections drafted by your attorney; instead relying upon the state law creating the protection.
Critical: court interpretation is the key issue when considering LLC’s and LP’s. LLCs are widely used and come in many variations. As such, courts in all jurisdictions have treated LLCs differently. By relying upon the use of an LLC for your holding company, you have no clarity regarding how a court will interpret your LLC.
Additionally, a limited partnership structure for your short-term rentals avoids the issue of setting up a disregarded entity discussed above. How? A limited partnership can never be a disregarded entity under the law because of the partnership arrangement. Also, because the limited partners in a limited partnership are never allowed to be in a position of management, judges almost never disregard the limited partnership as an entity – problem solved!
Generally, we many times recommend that a Limited Partnership holding company strategy will provide for the controlling partner/general partner to be a Wyoming LLC and the Limited Partner to be an Asset Protection Trust.
How Does A Limited Partnership As A Holding Company Provide Protection?
Certain state Limited Partnership statutes provide that upon the occurrence of a predefined event (lawsuit or creditor attack), a limited partner makes a unilateral withdrawal from the Limited Partnership.
How is this helpful? Instead of you deciding to move assets from one entity to another, the severance of a limited partner and general partner happens automatically – by operation of law! This is critical because most bankruptcy and civil courts will be looking to see if you made a fraudulent transfer to protect your assets in the event of a lawsuit or creditor attack. A fraudulent transfer is any transfer or moving of assets performed to avoid a creditor or lawsuit.
If you were to move assets from an LLC holding company upon the filing of a lawsuit, most courts would deem this action a fraudulent transfer and be able to track down and confiscate the assets to satisfy a judgment. However, by correctly structuring a Limited Partnership with the proper limited partner and general partner, your assets availability to a creditor can be severely limited, while allowing you to maintain control over the assets. The “disconnect” is statutory under a limited partnership and is very important because the disconnect is seen as a “unilateral withdrawal” as defined by a predetermined event and not a general partner discretionary move. This is not possible and will be interpreted as discretionary if done so in an LLC.
How should the general partner be determined? Although many variations can exist to this relationship, many clients prefer to establish a Wyoming LLC as the general partner and allocate 1% – 2% of asset ownership to the general partner. Why a Wyoming LLC? Many clients value privacy regarding their asset ownership. By establishing a Wyoming LLC as the general partner, privacy will exist regarding the client’s personal name and association with the Limited Partnership.
How should the limited partner be determined? The most effective way to designate a limited partner is with an Asset Protection Trust, with a 98% – 99% interest. By designating an asset protection trust as the limited partner, your asset protection trust will always be non-controlling and non-liable.
For example: A premises liability event happens at your lake house short term rental (a diving accident or swimming accident) and you are sued. In order to bring the lawsuit, the lawyer will have to sue your lake house LLC. Once served, the lawyer will learn the LLC is owned by a Limited Partnership holding company. However, the general partner identity will be private because it is set up through a Wyoming LLC. Additionally, the attorney will not be able to identify the Limited Partner because statute provides limited partners can remain private and not available publicly. Even once determined, the suing attorney will learn that the General Partner has a 1% ownership interest (few assets to attack). Remember, at this point the limited partner has been severed from the partnership by operation of law.
Additional Benefits of Establishing A Limited Partnership As A Holding Company
Limited Partnerships Are Perpetual. Depending upon the state you establish your LP, you are required to file an annual report and filing fees for LLC and other corporate structures. However, by selecting the best state to file your Limited Partnership entity, once filed, the LP is perpetual and does not need to be renewed, file an annual report or complete any other state maintenance. A properly established Limited Partnership can make a permanent fixture to your short-term rental asset protection strategy with little to no maintenance.
Privacy Can Be Established Through A Properly Structured Limited Partnership. For example, by establishing an Arizona Limited Partnership, only the general partner must be listed with the Secretary of State. Limited partners are completely private – which is a wonderful compliment when adding an asset protection trust as a limited partner to the Limited Partnership. As mentioned earlier, you can also keep the general partner private by creating a Wyoming LLC in the exclusive role of the general partner. This makes the entire LP structure private. However, privacy is NOT the same thing as anonymity. Privacy can still be broken by being sued, having your registered agent served with lawsuit paperwork and you being called to the witness to answer under oath as to the basis of your association with these entities. However, privacy helps make you a smaller target as you layer up your asset protection strategy!
Limited Partnerships Provide Easy Maintenance. There are no tax filing requirements under state law if your limited partnership is established in a favorable state. For example, in Arizona, there are no tax filing requirements: no annual report, no filing fees! You also are not required to file a state tax return! The only requirement under federal law is to file a simple federal Form 1065 partnership tax return, which is purely information and no additional layer of tax liability applied. Additionally, by linking your individual short-term rental LLCs to your LP, you are not required to file multiple K-1’s with your accountant – thereby saving money on accounting fees!
Summary – What Place Does A Limited Partnership Have In Your Short-Term Rental Protection Plan?
Although it may be common for attorneys to set up an LLC as a holding company for asset protection purposes, you create a host of unnecessary risks and costs with this strategy. There is a better way – the limited partnership. The limited partnership acts as a holding company for all your high-risk assets (STR’s), creating a strong asset protection strategy by creating an automatic severance between the limited partner (asset protection trust) and the general partner (Wyoming LLC), while also providing preferential tax treatment by allowing taxes and income to pass through each disregarded LLC while providing Limited Partnership protection.