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Saturday, February 16, 2013

LLPs - still the right mechanism?


Periodically a reader will ask whether we are still happy with the decision to hold properties in Limited Liability Partnerships. The most recent occurrence was right in the middle of filling out the LLPs' tax returns. Grrrr. At that moment, "nope, what a bad decision". But of course it is not that simple. The answer is complicated, beyond me, and you should seek professional advice. But for our personal situation, my thoughts are as follows:

This is a risk tolerance decision. The decision to hold property in some other way than in our own names is meant to recognize that this is a business, and the liability risk (e.g. from an accident involving a renter) should be contained to the business. So, the question is: will liability insurance be sufficient, or do we want the added protection of a limited liability construct? We chose to go with an ownership mechanism that would limit liability, but we made that decision when the most liability insurance that we could immediately find was $500K, which we felt was insufficient. Subsequently we moved our insurance to another company that provided $2M liability. If that had been in place initially, it would have been a more interesting decision. Not sure which way we would have gone, but that decision is behind us.

Given a choice to limit liability, the question is LLC, LLP, or something fancy such as a trust or corporation? LLC's are what most US residents use, but in my research it appears that for Canadians there is a possiblilty of double taxation. The tax treaty between the US and Canada provides for claiming back tax paid to the US government on Canadian tax forms (Foreign Tax Credit), but only if the income is of the same type. Canada doesn't seem to recognize the LLC construct which provides the limited liability characteristics of a corporation, but with the income being taxed as personal tax. If Canada thinks it is a Corporation, then it sees the tax paid in the US as corporate tax, and may not allow the Foreign Tax Credit to be applied against personal tax in Canada. But Canada does understand partnerships (which is what a limited liability partnership is), and the LLP has the same liaibility limitation characteristic...so we used LLPs. Of course an LLP is a partnership which requires more than one individual or entity, so if that is not your situation, then it may not apply.

A US Corporation would work, but reasearch at that time indicated that real estate rental income and capital gains from appreciation in real estate are taxed at higher levels with a corporation. Then, to avoid the same mismatch in income types as above, the US Corporation would need to be owned by a Canadian Corporation, with all the administration and cost that would bring with it.

Some advisors recommend a trust, or a "Cross Border Trust" (whatever that is). Sounded complicated and costly to maintain to me. A few that I know that went that way spend $1000 or more each year maintaining it. But I will admit to not fully investigating it.

So every year, I curse the LLP decision, but then after the taxes are done we are happy to have the extra layer of liability protection.

For what it is worth, the reader that recently asked me also asked his insurance agent, bank manager, and lawyer. "Ah, doen't worry about it...$2M insurance is good enough."; "LLP"; and "LLP" respectively. Please let me know what your advisors say!

5 comments:

  1. Hi -thanks for these great articles. I'm looking at investing and buying property personally vs. in an LLC/LLP. You mention a company that would provide $2M in liability. Can you tell me who that is? Any idea on insurance cost?

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  2. Hi there. Please see this previous post. We continue to have good luck with Katie at State Farm. Cheers.

    http://canadianswithusproperty.blogspot.ca/2011/08/insurance.html

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  3. Hi Gord & Brenda - thank you so much for all your valuable information and sharing your experiences. I recently established an LLP this past year to purchase my first US property in September. I am currently preparing my taxes and I was wondering if you designated a Tax Matters Partner on form 1065? I have read on some blogs that this is optional for many partnerships but I wasn't sure if having foreign partners made this a requirement. Any info or guidance would be greatly appreciated. Thanks again for all your assistance to fellow Canadian investors. - Ric

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  4. Hi Ric. Yes I list myself as the Tax Matters Partner. I believe it just lets the IRS know who to contact if there are questions. Gord

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    1. Great - thanks for the quick reply!

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