CHOICE OF ENTITY IN REAL ESTATE TRANSACTIONS ... - acrel

CHOICE OF ENTITY IN REAL ESTATE TRANSACTIONS
(With Emphasis On Partnerships
And Limited Liability Companies)
SANFORD J. LIEBSCHUTZ
Roc hester, N.Y .
STEVEN A. WATERS
San Antonio, Texas
Am erican College of Real Estate Lawyers
1994 Spring Meeting
Tucson, Arizona

Choice of Entity in Real Estate Transactions
(With Emphasis On Partnerships
And Limited Liability Companies)
Table of Conten ts
Page
I. SCOPE OF DISCUSSION .......................................................... 1
II. OVERVIEW OF CHOICE OF ENTITY PROCESS ....................................... 1
A. IDENTIFYING OBJECTIVES ............................................. 1
B. IMPORTANT FACTORS IN SELECTING THE BUSINESS ENTITY ............. 2
1. Form ation a nd M ainten ance Req uirem ents ......................... 2
2. Extent of Liability ............................................. 2
3. Management and Control ....................................... 2
4. Tran sferab ility of Inte rests ...................................... 2
5. Legal Flex ibility .............................................. 2
6. Continuity of Existence ......................................... 2
7. Methods For Getting Money Out ................................. 2
8. Tax Considerations ............................................ 2
C. SUMMARY OF ENTITIES COMMONLY USED BY REAL ESTATE OWNERS .... 2
1. Sole Proprietorships ........................................... 3
2. General Partnerships and Joint Ventures ........................... 3
3. Limited Partnerships ........................................... 3
4. Registered Limited Liability Partnerships ........................... 3
5. Corporations ................................................. 4
6. S Corporations ............................................... 4
7. Limited Liability Companies .................................... 4
D. SOURCE MATERIALS .................................................. 4
E. UNIFORM LIMITED LIABILITY COMPANY LEGISLATION .................. 5
1. Background .................................................. 5
2. IRS Rulings Since 1988 ........................................ 5
3. NCCU SL Project ............................................. 6
4. Sup plem ental M aterials ........................................ 7
III. FEDERAL INCOME TAX CLASSIFICATION -- INTRODUCTORY DISCUSSION ........... 7
A. SUMMARY OVERVIEW OF CORPORATE CHARACTERISTICS .............. 8
1. Formation Alone Is Not Enough .................................. 8
2. Four Critical Characteristics ..................................... 8
3. "Other Factors" ............................................... 8
4. History of the Regulations ...................................... 9
B. DETAILED DISCUSSION OF CORPORATE CHARACTERISTICS .............. 9
1. Continuity of Life ............................................. 9
2. Centralization of Management ................................... 10
3. Lim ited Lia bility .............................................. 11
4. Free Transferab ility of Inte rests .................................. 12
i

5. Obtaining a Ruling ............................................ 13
IV.
DETAILED, COMPARATIVE DISCUSSION OF LIMITED PARTNERSHIPS, LIMITED
LIABILITY COMPANIES AND S CORPORATIONS .................................... 14
A. FORMATION AND MAINTENANCE REQUIREMENTS ...................... 14
1. Limited Partnerships ........................................... 15
2. Limited Liability Companies .................................... 16
3. S Corporations ............................................... 18
B. EXTENT OF LIABILITY ................................................. 19
1. Limited Partnerships ........................................... 20
2. Limited Liability Companies .................................... 21
3. S Corporations ............................................... 22
C. MANAGEMENT AND CONTROL ......................................... 23
1. Limited Partnerships ........................................... 23
2. Limited Liability Companies .................................... 26
3. S Corporations ............................................... 28
D. TRANSFERABILITY OF INTERESTS ...................................... 29
1. Limited Partnerships ........................................... 29
2. Limited Liability Companies .................................... 30
3. S Corporations ............................................... 31
E. LEGAL FLEXIBILITY ................................................... 32
1. Limited Partnerships ........................................... 33
2. Limited Liability Companies .................................... 33
3. S Corporations ............................................... 34
F. CONTINUITY OF EXISTENCE ........................................... 35
1. Limited Partnerships ........................................... 35
2. Limited Liability Companies .................................... 36
3. S Corporations ............................................... 37
G. TAX CONSIDERATIONS ................................................ 38
1. Limited Partnerships ........................................... 39
2. Limited Liability Companies .................................... 40
3. S Corporations ............................................... 42
H. METHODS FOR GETTING VALUE OUT ................................... 43
1. General Rule - Partnerships ..................................... 43
2. Com parison Su mm ary ......................................... 43
3. Gains v. Losses ............................................... 44
4. Shifting Taxable Items ......................................... 44
V. SUMMARY OF THE VARIOUS CONSIDERATIONS ................................... 44
A. GENERAL OVERVIEW ................................................. 44
B. ENTITY BY ENTITY COMPARISON ...................................... 45
1. One Ow ner - P roprietorship , S Co rp, LL C or L imited Partnership ....... 45
2. Multiple Owners -- Numerous Options ............................. 45
C. COMPARISON OF STRUCTURES CHART ................................. 48
VI. CONCLUSION ................................................................... 48
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Attachments
Appendix A
LLC & LLP State Legislation
Appendix B IRS Reven ue R ulings / P rivate Le tter R ulings (C lassification Issu es) F or L LC 's
Appendix C Com parison O f Structures Chart
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CHOICE OF ENTITY IN REAL ESTATE TRANSACTIONS
(With Emphasis On Partnerships
And Limited Liability Companies)
By
Sanford J. L iebschutz
Steven A . Waters
II.
SCOPE OF DISCUSSION.
This article analyzes and compares various business entities available to parties who desire to acquire, own,
operate, or develop real estate, and discusses factors relevant to the decision of the best entity for the particular
situation. Although tax considerations are usually very important in the selectio n process and w ill be highlighted
in this paper, there is not an exhaustive treatment of tax issues. However, because federal income tax pass-through
treatment is required by most real estate owners, this paper places much greater emphasis on partnerships and
limited liability companies than on other entities. Mainly, for comparative purposes (although they can be the
entity o f choice), subcha pter S corporation s are co vered in som e detail, as we ll.
The authors note, with modest apology, the disproportionate number of references to Texas law. The
general principles, however, are the sam e for most jurisdictions, although details differ.
IV.
OVERVIEW OF CHOICE OF ENTITY PROCESS.
B. IDENTIFYING OBJECTIVES.
It is elementary that a lawyer cannot provide effective counsel on entity selection without first understanding
the client's current business situation and objectives. Among the frequently relevant issues are:
! Nature of the real estate involved;
! Proposed business objectives in acquiring the real estate (e.g. for development, lease, operation
(e.g. hotel) or later resale);
! Likelihood that the business objective will change;
! Number, nature, and experience of the parties to the transaction;
! Type of business form in which the parties to the transaction are currently operating and the
ability to convert to another form without suffering adverse tax consequences;
! Financial resourc es of the parties, and the ne ed for and timing of obtaining outside capital;
! The parties' tax situation and objectives, and whether the objectives are different for different
owners; and
! The importance of limited liability.

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Without a clear understanding of the client's situation and objectives, a practitioner cannot effectively
recommend the best entity choice for the proposed transaction.
D. IMPORTANT FACTORS IN SELECTING THE BUSINESS ENTITY.
The basic factors that typically influence the selection of the ownership entity in a real estate transaction
include:
the entity;
business;
2. Formation and M ainten ance Req uirem ents: The ease and expense of forming and maintaining
4. Extent of Liability: The extent to which the owners are liable for the obligations of the
6. Management and Control: The extent of control desired by the ow ners;
8. Tran sferab ility of Interests: The extent and ease by which an ownership interest in the entity
may be transferred;
10. Legal Flexibility: The extent to which the actions of the owners of the business are governed
and limited by law (and their ability to contractually vary that result) and the ease with which the form of business
can be changed;
12. Con tinuity of Existence: The e xtent to whic h the o wners desire that th e entity have contin uity
of existence;
paid; and
14. Methods For Getting Money Out: The key issue for many owners -- when and how do I get
16. Tax Considerations: The tax treatment of the entity, its owners and em ployees.
This paper will test the more imp ortant entity forms against these factors.
F. SUMMARY OF ENTITIES COMMONLY USED BY REAL ESTATE OWNERS.
This Section C. provides a brief, rudimentary summ ary of the forms of own ership used with varying
frequency in real estate transactions. Although some of the entities generally are not preferred under the current
state of the la w, for reaso ns that will be expla ined (u sually, tax and liability reasons), each is mentioned because
a unique co mbination of facto rs imp ortant to a particular client m ay lead to us e of a fo rm that, in mo re typic al
circumstances, would be considered inadvisable. However, the extended discussion later in the pape r prim arily
involves a c ompariso n of partners hips (e specially limited pa rtnersh ips), lim ited liability com panie s and, main ly
for illustration, subchapter S corporations.
2. Sole Proprietorships.
In a sole proprietorship, the business is conducted by an individual who owns all of the property.
There are no formal requirements for a sole proprietorship to exist other than, perhaps, dedication by the proprietor

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of a portion of his or her individual assets to a specific business purpose and, if appropriate, the filing of an
assumed business name certificate.
4. General Partnerships and Joint Ventures.
A general partnership is, by statutory definition, an association of two or more persons to carry on
a busin ess for profit as co-owners. A joint venture is, essentially, a general partnership with a limited purpose
(which has led to its widespread use for real estate project ow nership). Therefore, to the limited extent they are
discussed in this paper, th ese tw o entities are co nsidered the sam e. A g enera l partne rship is n ot taxe d as a separa te
entity from its partners.
6. Limited Partnerships.
A limited partnership (sometimes "L P'ship") is a partnership that has one or more general partners
(who are liable for the obligations of the partnership) and one or more limited partners (liable only to the extent
of their actual or committed investment in the partnership). Like general partnerships, a limited partnership is not
taxed as a separate entity from its partners. Because the creation of a limited partnership involves the filing of a
certificate with the state, that form tends to be somewhat more formal than general partnerships, although a limited
partnership can b e created by oral ag reem ent.
8. Registered Limited Liability Partnerships.
A registered limited liability partnership ("LLP") is a special type of general partnership in which,
in certain circumstances, some LLP partners are not liable for debts and obligations of the partnership that arise
from errors, omissions, negligence, incompetence, or malfeasance committed without the knowledge of the
protected partner by another partner or employee not supervised by the protected partner. This has been described
as "a d ramatic break from trad ition, . . ." in A . Brom berg and L . Ribste in, Bromberg & Ribste in on Partnership ,
(1988) [hereinafter "BROMBERG AND RIBSTEIN"], page 5:83, describing the creation of an LLP under the
Texas Uniform Partnership Act, TEX. REV. CIV. STAT. ANN. art. 6132b, § 45 (Vernon 1991). Note that, for
Texas partnerships created after December 31, 1993, LLP's are created under the new Texas Rev ised P artners hip
Act, TEX . REV . CIV . STA T. ANN ., art. 613 2b-1 , § 3.08 (Vernon 1994). A p artnership in Texas obtains
registered limited liability partnership status by filing required identify ing inform ation w ith the S ecretary of S tate
and a fee of $ 200 (up in 1993 from the orig inal $1 00 fee). [VIP NOTE: Registration must be renew ed annually
in the same way the status is originally created. For professional service organizations, this annual expense may lead
to the use of professional LLC's, now allowed in several states, at least where local tax issues don't get in the way.]
Also, an LLP must maintain $100,000 of liability insurance covering the types of torts for which liability under
the statute is shielded. Partners in an LLP remain liable for their own torts and the partnership itself is liable for
the torts of partners and employees.
Note that at least in some states (e.g. Texas), a limited partnership can also be an LLP, which can give some
measure of additional protection to a general partner when there are several active general partners.
Do not consider LLP's and limited partnerships as substitutes for each other, or as alternatives to achieve
the same objectives. An LLP is still a general p artners hip whose partners hav e joint and several liability (tort
and/or contract, depending on the state), with the limited shield of personal assets in certain circumstances that is
described abov e. For example, if the partnership properly incurs an obligation for borrowed money, LLP status
does not do for the general partner what limited partne r status w ould do for a limited partner. On the other hand,
in a circumstance where LLP status provides a shield from particular tort liability, then a shielded LLP p artner is
in much the position of a limited partner -- the entity and its assets are fully liable, but the partner's personal, nonpartnership
assets generally are protected.

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As shown in Appendix A, a number of states have followed Texas' lead by adopting LLP enabling
legislation, and several others have pending legislation.
10. Corporations.
A corporation is a lega l entity formed under state law that provides its ow ners -- the shareh olders --
with limited liability. The law treats corporations as having a personality and existence distinct from that of its
owners and, accordingly, taxes them as entities separate from their shareholders.
12. S Corporations.
An S Corporation (sometimes "S Corp") is a so-called "small business corporation" that has made
the required election under the Internal Revenue Code of 1986, as amended (the "IRC"), to be treated as having
the federa l incom e tax attributes of a pa rtnersh ip. On non-tax issu es, the S Corp is treated the same as other
corporations.
14. Limited Liability Companies.
A limited liability comp any (sometimes "LLC") is a no n-corporate entity organized under a state
enabling statute that affords its owners -- called "mem bers" -- the lim ited liability of a corpo rate shareho lder w hile
also providing the opportunity for the flow-through tax treatment of a partn ership . This d ual be nefit is expected
to make LLC's very popular in many bu siness contexts, includ ing rea l estate. B ut, as discussed below, in some
states there are local tax issues that are a serious deterrent to using this otherwise desirable form of ownership.
H. SOURCE MATERIALS.
Although some of the following statutes are de scribed in detail elsewhere in the paper, they are collected
here for convenience:
"UPA"
"ULPA"
"RULPA"
"RUPA"
"ULLCA"
"TUPA"
"TRLPA"
Uniform Partnership Act (1914), promulgated by the National Conference of Commissioners on
Uniform State Law s ("NCC USL ").
Uniform Limited Partnership Act (1916), promulgated by NCCUSL.
Uniform Limited Pa rtnersh ip Ac t (1976), pro mulgated by N CCUSL to replace ULPA, as amended
by replacement Uniform Limited Partnership Act (1985).
Uniform Partnership Act (1993), approved and recommended by NCCUSL for enactmen t, August
6, 1993.
Draft Uniform Limited Liability Company Act, currently being drafted by a Drafting Committee
appointed by NCCUSL in summer 1992. (See a full description of ULLCA in Section E., below.).
Texas Uniform Partnership A ct, art. 6132b, Texas Revised C ivil Statutes.
Texas Revised L imited Partnership Act, art. 6132a-1, Texas Re vised Civil S tatutes (g enera lly, but
not identically, conforming to 1985 R ULP A).

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"TRPA"
"TLLCA"
Texas Revised Partnership Act, art. 6132a-1.01-10.04, Texas Revised Civil Statutes (generally, but
not identically, conforming to RUP A).
Texas Limited Lia bility Company Act, art. 1528n, §§ 1.01-9.02, Texas Revised Civil Statutes (Supp.
1993), in its second generation after 1993 amendments.
J. UNIFORM LIMITED LIABILITY COMPANY LEGISLATION.
2. Background.
The LLC movement focused on obtaining in a single business entity a combination of limited liability
for all of the owners of the business with federal partnership taxation of the entity. No othe r business entity form
offered this unique c ombinatio n. The origin al dom estic lim ited liability company statute was adopted in Wyoming
in 1977. The Wyoming LLC Act was tailored in a bulletproof manner to, it was hoped, achieve a partnersh ip
taxation ruling; that is, it required that all LLC's conform to a certain format that was anticipated to be looked upon
favorably by the Internal Revenue Service. However, the Wyoming Statute did not receive approval by the
Internal Rev enue Service un til a 1988 public ruling (Rev. Rul. 88-76). Florida enacted LLC Legislation in 1982,
but received no ruling as to tax ability as a partnership until 1993 (R ev. Rul. 93-5 3).
4. IRS Rulings Since 1988.
The Internal Revenue Service conducted a study before its 1988 decisio n on the W yom ing LLC A ct;
since its 1988 ruling, the Service has enco uraged the proliferation o f state Limited Liability Com pany enactmen ts
through release of a multitude of private letter rulings and thirteen more public revenue rulings, through early
1994. As a result, states enthusiastically responded, many at the urging of various bar associations. As of
February 1994, 37 states have adopted LLC Statutes, the vast majority of them (30) in 1992 and 1993. LLC
legislation is pending in all remaining states and the District of Columbia and it is anticipated that a substantial
number of additional state statutes will be adopted in 1994, including New York and California, both of whom
have had pending legislation for at least two years. (See Appendix A for a list of states and reven ue rulings).
6. NCCU SL Project.
b. Initiation.
The National C onference of Com missioners on Uniform State Laws ("NCCUSL") appointed
a study com mittee whic h in ea rly 1992 recom mended that a L imited Liability Company project be undertaken.
A Drafting Comm ittee was appointed in the summer of 1992. Since then, the Drafting Committee has been
working and has prepared a draft Uniform Limited Liability Company Act ("ULLCA"). The draft act received
a first reading at the annual meting of the Conference in August of 1993 and it is anticipated th at a second (and,
it is hoped) final reading and approval will take place at the NCCU SL annual meeting scheduled for August of
1994.
d. Seco nd G enera tion Statute.
The ULLCA draft has attempted to be a second gene ration L LC A ct. The variou s state ac ts
were patterned after a variety of formats and differ widely. As noted above, the Wyoming Statute was adopted
in a bulletproof format and has been followed by a number of states. On the other hand, recent state statutes have
been much m ore flex ible. Th e NC CU SL study noted that while pro moting flex ibility for each state en actm ent,
state law d iversity might ultim ately im pede the pre dictab ility and therefo re the u tility of interstate Limited Liability
Com pany busin ess activity; thu s they saw the ne ed for a Un iform Act.

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f. RUPA/RULPA M odel, But Significant Differences.
Initially, the ba sic structure of the draft U LLCA followed the Revised Un iform Partnership Act
(RUPA) and where applicable the Revised Uniform Limited Partnership Act (RULPA) as m odels. It also included
conc epts from the M odel B usiness Co rporation A ct. However, in the course of the drafting and revision, some
of RUPA/RULPA ideas have been discarded to more clearly align an LLC as its own creature with significant
differences from the trad itional p artners hip en tities, although retainin g the p artners hip pass-through taxa tion go al.
h. Flexibility.
The major determination of the D rafting Com mittee was that ULLC A sh ould be a flexible
statute offering the ability to tailor an LLC to various needs. For instance it has provided for the organization of
LLC's by a single in dividu al (the issue of whether this will be acceptable to the Service is still open. See the
discussion in Section V.B.1., below). It also provides that an LLC may be organized for any lawful purpose, rather
than requiring it to be organized for profit. This is more in the corporate mode rather than in the partnership mode.
ULLCA in its current draft form also provides for conversions of partnerships, limited partnerships and
corporations to LLC 's, and for mergers among the various entities.
j. Open Issues.
There are some issues still to be resolved, such as: should any portion of an operating
agreement be required to be in writing; what is the extent of fiduciary duties among mem bers and managers;
defau lt rules for distributions; disassociation rules; and what constitutes notices of limitations on authority, among
others.
l. IRS Blessing.
If approved by the Conference at its 1994 summer meeting, it is hoped by the D rafting
Comm ittee that ULLCA w ill receive an affirmative blessin g by the Reven ue Service . This w ould enco urage its
adoption as a second generation statute replacing early statutes or providing for the basis to m odify existing state
LLC statutes.
8. Sup plem ental M aterials.
Ribstein and Keating on Limited Liability Companies Shepard's/McGraw-H ill, Inc. (2 volumes)
(updated annually) This set contains a through analysis of all factors relating to Limited Liability Companies, and
a detailed discussion of business organization choice, business and ta x issue s. It com pares the diffe rent state
statutes with respect to various issues relating to formation and operation of LLCs. It includes the text of all state
statutes, and the Prototype Act prepared by the section of Business Law of the American Bar A ssocia tion an d all
statutory cites and forms.
Gue, Thomas Earl - Understanding the Lim ited Lia bility Company : A Basic Comparative Primer (Parts 1
and 2) 37 Sou th Dako ta Law R eview, V olume 37, Issues 1 and 3 (1992) This article is a scholarly view of the
entire subject of Limited Liability Com panie s and related legislation plus an in depth discussion of the federal
taxation issues.
VI.
FEDERAL INCOME TAX CLASSIFICATION -- INTRODUCTORY DISCUSSION.
The controlling desire for partnership treatment for federal income tax purposes often quickly narrows the
choice of entity process to a comparison of partnerships (limited or general, but more often limited), LLC's and,

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less frequently, S Corps. The price exacted by the IRS for partnership tax treatment -- for partnerships and limited
liability com panie s -- is that th e entity "look" m ore like a partners hip tha n a co rporation, m easured ag ainst ce rtain
characteristics. S Co rps are like other corporations, except that certain very strict statutory limitations must be
observed. Therefore, this discussion of partnersh ip tax treatme nt and corporate characteristic s applies only to
partnerships and LLC's.
[Because of the impo rtance of the topic to the choice o f entity discussion, and because references to the
issue appear frequently in this paper, it was felt that a discussion here would be useful. But, in some
later sections, the substantive issue is treated relatively fully, to avoid constant cross-references (and
page-flipping). Much of the following discussion is taken from C lifton, Fijolek and Sim on, An
Expanded Analysis of Texas Limited Liability Companies, and with citations thro ugh July 1, 1993 . This
Article III. is referred to elsewhere as "TA X CL ASSIF ICAT ION."]
B. SUMMARY OVERVIEW OF CORPORATE CHARACTERISTICS.
2. Formation Alone Is Not Enough.
Formation of an entity as a limited partnership or an LLC is not sufficient to assure partnership tax
treatment for federal income tax p urpo ses. Instead, the entity must be stru ctured to hav e (or not have) certain
characteristics. The specific entity created for the specific transaction, having (or not) one or more characteristics
that it is allowed but not required to have, must be tested against certain characteristics to determine federal income
tax classification.
4. Four Critical Characteristics.
The definitions of partnership and corporation are found in Section 7701(a)(2) an d (3), respectively,
of the Internal Revenue Code of 1986, as amended ("Code"). Treasury Regulations §§ 301.7701-1 through -3 (the
"Regulations") expand the basic definitions and address the classification of organizations as partnerships, or as
associations taxab le as co rporations. T reasury Re gulations § 301.7701-2(a)(1 ) lists the fo llowin g as the six
characteristics that distinguish a corporation from other forms or organizations, such as partnerships:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
associates;
business objective toward a division of profits;
continuity of life;
centra lized m anag ement;
limited liability; and
freely transferable interests.
Treasury Regulation § 301.7701-2(a)(2) notes that the first two characteristics -- associates and a profit-sharing
motivation -- are com mo n to all bu sine ss organiza tions and do n't contribute anything to the determination whether
an unincorporated organization shou ld be cons idered a partnership (good) or an association taxable as a corporation
(bad). Treasury Regulations § 301.7701-2(a)(3) accordingly makes the remaining four corporate characteristics
the keys to the classification issue.

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Thus, to avoid being taxed as a corporation for federal income tax purposes, an entity must have two or less
of the four critical corporate characteristics.
6. "Other Factors".
Whether an organization possesses or lacks a particular corporate characteristic requires a facts and
circumstances evaluation. Treasury Regulations § 301.7701-2 (a)(1). "Othe r factors" not listed in the regulations
also may be co nsidered w hen c lassifyin g an o rganization. See Larson v. Commissioner, 66. T.C. 159 (1976); Rev.
Rul. 79-106, 1979-1 C.B. 448 (identifying seven factors that are not significant "other factors"); and GCM 38281
(the Service appa rently con clude d that th e W yom ing LLC statute's treatme nt of W yom ing LLC's as "en tities" could
cons titute a significant "other factor" in determining partnership or association classification). To date, how ever,
the Service has not considered any "other factors" in any classification ruling involving an LLC.
8. History of the Regulations.
For those interested in more detail, Section 3.06 of McKee, Nelson and Whitmire, Federal Taxation
of Partnerships and Partners, second ed ition (1990), contains an instructive discu ssion of the history of Treasury
Regulations § 301.7701-1 through -3, which is a fascinating example of the relationship among the administrative,
legislativ e and judicial branc hes of the fed eral go vernment.
D. DETAILED DISCUSSION OF CORPORATE CHARACTERISTICS.
2. Continuity of Life.
b. The Regulations.
Con tinuity of life exists when an organization is not dissolv ed on the death, insanity,
bankruptcy, retirement, resignation or exp ulsion of any mem ber. Treasury Regulations § 301.7701-2(b )(1).
Conversely, an organization that dissolves on the happening of one of these events to any member does not have
continuity of life.
Final regulations effective June 14, 1993 (T.D. 8475, 1993-23 IRB 11) relaxed the former position. The
Regulations now provide tha t a limited partne rship will not have continuity of life if, upon the occurrence of any
specified withdraw al event for a general partner, the partnership may be continued by consent of (i) the remaining
general partners or (ii) at least a majority in interest of all remaining partners. The movement to a majority in
interest standard (versus the form er unanim ous conse nt) by the final Regulations is a positive development in the
classification area, allowing greater freedom to provide for continuation of the business on the separation o f a
mem ber. Unfortunately, the Regulations refer only limited partnerships and do not add ress LLC's.
d. The Service's Position.
Rev. Proc. 89-12, 1989-1 C.B. 798, as applied to limited partnerships organized under a statute
corresponding to the RULPA, requires only the vote of a majority in interest of the lim ited pa rtners to continue
the partnership on the removal of a general partner. Rev. Proc. 92-35, 1992-18 I.R.B. 21, modified Rev. Proc. 89-
12 by providing that continuity of life will not exist in a limited partnership formed under a statute conforming to
RULPA if the partnership may be continued upon the bankruptcy or removal of a general pa rtner only on the vote
of (i) the remaining general partners or (ii) at least a majority in interest of all remaining partners. As n oted in
Section B.l.a., above, now final Treasury Regulations § 301.7701-2(b)(1) also applies this more favorable standard.

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Until recently, the Service's ruling position for LLC's to avoid continuity required unanimous consent for
continuation. For example, in PLR 9010027, the Service ruled that a Florida LLC had continuity of life because
its articles (as permitted by the Florida Act) allowed continuation after the occurrence of a dissolution event by
a majority (rather than unanimous) vote. Consistently, the Service ruled in PLRs 8937010, 9029019 and 9030013,
that a Florida LLC lacked continuity of life when its articles required a unanimous vote to con tinue th e LL C's
business upon a m ember's ceasing to be an LLC mem ber.
The situation for LLC's is improving. Another private letter ruling, PLR 9308027, expressly stated that an
LLC did not have continuity of life where dissolution occurred upon specified events and the election to continue
the LLC was mad e by a majo rity of m anag ing directors and a majo rity in inte rest and number of all remaining
mem bers.
f. Conclusion.
Some states' statutes, e.g. W yom ing's, preclud e con tinuity o f life; othe rs (e.g., T exas) perm it
flexibility in the o rganizational structu re of the LLC, thereby allow ing the LLC mem bers to determine whether
their LLC will or will not have the corporate characteristic of con tinuity of life. Unless th e me mbers take full
advantage of the available flexibility in the operating agreement, however, even LLC's formed in states where the
flexibility is allow ed w ill not ha ve co ntinuity of life. Th anks to Rev. Proc. 92-35 an d the new ly revised Treasury
Regulations § 301.7701-2(b)(1), it now is apparent that a majority in interest standard (not unanim ity) exists
regarding the effect of having the ability to continue a limited partnership on the oc currence o f a disso lution e vent.
Further, because PL R 9308027 has ado pted the same m ajority in interest standard for an LLC, it now appears that
LLC's and limited partnerships will be treated the same on the continuity of life issue. One day, perhaps, the
Service will treat LLC's and limited partnerships consistently on all classification issues.
4. Centralization of Management.
b. The Regulations.
An organization will have centralized managem ent if any person or group of persons consisting
of less than all the owners has the continuing exclusive autho rity to make management decisions for the business.
Treasury Reg ulation s § 30 1.7701-2 (c)(1). T he ke y is the man ager's a bility, as a man ager a nd not as an own er, to
contractually bind the organization. But, the Service recognizes a safe harbor of 20% -- Rev. Proc. 89-12 provides
that a limited partnership w ill not have centralization of man agem ent where general partners own 20% or more
of the partnership interests. The theory is that a g enera l partne r with such a substantial stake as an ow ner is acting
for itself, not just in a representative capacity for the limited partners.
d. The Service's Position.
(1) The Service's po sition is re ason ably c lear that centralization of manag ement is
avoid able for limited pa rtnersh ips. W ith two favorable LLC private letter rulings relating to limited partnersh ip
safe harbors in the area of continuity of life and free transferability of interests, and the frequent reference by the
Serv ice to R ev. Proc. 89 -12 in private letter rulings inv olving LLC 's, it was reasonable to conclude that an LLC
managed by m anag ers who own 20% or more of the interest in the LLC w ould not have centralized management
(in other words, that non-manager members and limited partners, and member-managers and general partners,
would be considered functionally the same). Quite surprisingly, the Service in Rev. Rul. 93-6, held that a Colorado
LLC with five members, all of whom were also managers, had centralization of management because management
of the LLC was vested in managers, not members. Rev. Rul. 93-6, 1993-3 I.R.B. 9, 10.

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(2) Rev. Rul. 93-6 appears to directly contradict the ap plicab le Treasury Regulations,
which provide tha t "an organization has ce ntralized manag ement if any person (or any group of persons which
does not inc lude a ll the mem bers) has continuing exclusive authority to make the management decisions necessary
to the conduct of the business for w hich the organization w as formed." Treasury Regulations Section 301.7701-
2(c)(1) (emph asis supplied). Th e apparen t rationale for the Service's holding that the C olorado LLC had
centralized management is that the decision-making authority rested with the members as elected managers, not
as members. Nevertheless, the express language of the Treasury Regulations, stating that centralized management
exists only where the decision-making group does not include all members of the organization, is clearly
contradictory.
(3) The Service's emphas is on the electiv e position of m anag ers sug gests th at only
LLC's that reserve management exclusively to their members, as members, can avoid having centralization of
manage ment. This holding in Rev. Rul. 93-6 is unfortunate and may create a significant problem for many existing
LLC's that vest manage ment in m anag ers and possess e ither (bu t not both) of the characteristics of free
transfe rability of interests or continuity of life. Those LLC's will now have to disclose this issue in their tax
returns, because their partn ership classification will be in direct conflict with published authority on the issue. And
in Colorado, that statute requires that LLC's be managed by managers.
(4) There is som e hop e that the Service w ill soon remedy th is anomaly. As part of
its business plan for 1993, the Service indicated that it will issue a revenue procedure providing guidance on the
classification o f LLC s. High lights & Doc uments, January 19, 1993, 1415, 1419. 1
f. Conclusion.
While many LLC statutes allow management either by managers or members, as provided in
the LLC's articles of organization, the cu rrent position of the S ervice appe ars to be that unless m anag ement is
reserved to the members, the LLC will have centralized management. If managers/members are considered
comparable to general partners in limited partnerships, then Rev. Proc. 89-12 supports the position that an LLC
shou ld not have centralized management if the managers own at least 20% of the LLC interests. Aside from Rev.
Proc. 89-12, an interesting question arises if an LLC reserv es m anag ement to th e me mbers who in turn designate
one member to act on all but certain specified decisions pursuant to statutory proxy and other voting rights. The
effectiveness of such an arrangem ent to avoid centralization of m anagem ent characterization may turn on whether
the designated "ma nagin g member" w ould have the sam e app arent a uthority as a g enera l partne r in a partnership,
as described in Treasury Reg ulation s § 30 1.7701-2 (c)(4). C ompare th e centralized man agem ent an alysis in
Examples (2) and (3) to Examples (4 ), (5) and (6) o f Treasury R egula tions § 301.7701-2(g ).]
6. Lim ited Lia bility.
b. The Regulations.
An organization will have the corporate characteristic of limited liability if no member of the
organization has personal liability for the debts of the organization. Treasury Regula tions § 301.7701-2(d )(1).
For limited partne rships, limited liability m ay be present wh ere the gene ral partner is w ithout substantial assets
availab le to the partnership's creditors and is a "dumm y" acting as the agent for the lim ited partners. Treasu ry
Regulations § 301.7701-2(d )(2).
1
A post-script -- Revenue Procedure 95-10 was issued in late December 1994.

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d. The Service's Position.
Because of th e statutory lim itatio n of a m em ber's liability (which some states allow to be varied
in the operating agreement), no published LLC classification ruling has found that an LLC lacked limited liability.
Such a ruling shou ld be o btaina ble for a n LLC organiz ed in a state (e.g. Texa s) tha t auth orizes th e LL C's articles
or operating agreement to impose member liability fo r the LLC's debts, if the particular L LC in clude s the liab ility
provision. In the context of limited partnerships, the Service has provided specific guidelines in Rev. Proc. 89-12
and GCM 39798, 1989-7 I.R.B. 22 (10/24/89), that describe minimum net worth safe harbor requirements for
general partners for advance ruling purposes.
f. Conclusion.
As a gen eral rule , the LL C or p artners hip form is chosen because of the ability to (i) limit the
liability of the members and (ii) achieve classification as a partnership for federal income tax purposes.
Accordingly, LLC 's usually concede the corporate characteristic of limited liability, which requires careful
organization to avo id the re maining th ree co rporate characteristic s, to protect partnership classification status.
Limited partnerships have a bit more structural flexibility on the liability issue.
8. Free Transferab ility of Inte rests.
b. The Regulations.
Me mbership interests are not freely transferab le under Treasury Regulations § 301.7701-2(e)(1)
unless each member (or those members owning substantially all of the interests in the entity) has the po wer,
without the consent of the other members, to substitute for himself in the same organization a person who is not
a member of the organization. For the req uisite po wer o f substitution to exist, the mem ber m ust be able, again
witho ut con sent of the oth er members, to confer upon the member's transferee all the a ttribu tes o f the me mb er's
interest in the organization. Im portantly, free transferability o f interests will not exist w here th e votin g rights
associated with a member's interest are not transferable, even if the econom ic rights associated with the interest
are fully transferable.
d. The Service's Position.
Until PLR 9210019, eve ry published private letter ru ling co ncern ing the classification of L LC 's
created under a domestic LLC statute found the absence of free transferability of interests because unanimous
member consent was required to approve a substitute member, even though no such unanimity requirement applied
to transfers of the economic interests. Fortunately, PLR 9210019 confirms that a more flexible arrangem ent works,
too. There, it was determined that approval of a member's transfe r requires on ly the conse nt of the sole
manager/member, and the transfer of the manager/member's interest requires only the approval o f a majority in
interest of the m embers. S ubse quen tly, PLR 92 19022 held tha t appro val of o nly a majority in interest of the nontransferring
mem bers w as required to sub stitute a m ember for another. Finally, in Rev. Proc. 92-33, 1992-17
I.R.B. 28, the Service supplemented Rev. Proc. 89-12 by stating that with respect to the "substantially all" phrase
found in the Treasury R egula tions, a p artners hip w ill lack free transferability of interests if throughout the life of
the partnership the partnership agreement expressly restricts the transferability of partnership interests representing
more than 20% of all interests in p artners hip ca pital, income, gain , loss, de ductio n and credit.
f. Conclusion.
The Treasury Reg ulation s divide me mbership interests into two components in testing for free
transfe rability of interests: (i) econ omic rights -- i.e. the right to profits and distributions, and (ii) voting and

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management rights. As long as further member consent is required to approve the transfer of voting and
management rights, the entity w ill not have free transferability o f interests where the econ omic rights are free ly
transferable. Thus, the critical question on the issue of free transferability of interests is: What level of other
member consent is required? N o free tra nsfera bility of in terests exists in the context of a limited partnersh ip where
the general partner has the absolute discretion to approve transfers of lim ited partner inte rests. See Treasury
Regulations § 301.7701-3 (b), Ex ample (1) and P LR 9 014030. See also PLR 9210019, discussed above, regarding
manager approval of member transfers. Similarly, in Rev. Rul. 88-79, 1987-2 C.B. 361, the Service determined
that a Missouri business trust did not have free transferability of interests where a person could not become a
substituted participant without the approval of a majority of the managers. Then, in PLR 9219022, discussed
above, the Service ruled that consent of a majority in interest of non-transferring mem bers w as sufficient to
approve a substitution. Until PLR 9210019, it was uncertain whether the Service had adopted a more restrictive
view toward LLC's by allowing only unanimous consent to transfers to avoid the characteristic of free
transferability of interests. That question appears to have been resolved in favor of a majority in interest and/or
manager approval standard for LLC's.
10. Obtaining a Ruling.
b. Revenue Procedures.
In Rev. Proc. 88-44, 1988-2 C.B. 634, the Service removed from its "no ruling" area the
classification of LLCs under Co de Section 7701, and then im mediately issued Rev. Rul. 88-76 classifying a
Wyoming LLC as a partnership for federal income tax purposes. Shortly thereafter, the Service issued Rev. Proc.
89-12, 1989-1 C.B. 798, as sub sequ ently amplified by Rev. Proc. 91-13, 91-1 C.B. 477, Rev. Proc. 92-33, 1992-17
I.R.B. 28 and R ev. Proc. 92 -35, 1992-18 I.R .B. 21 , dealing with the conditions and requirements under which the
Service would consider the classification of an organization as a partnership for federal income tax purposes. Rev.
Proc. 93-1, 1993-1 I.R.B. 10, provides further information concerning the current ruling procedure process.
d. Applicability of Rev. Proc. 89-12 to LLCs.
Although it does not dire ctly m ention LLC 's, Rev . Proc. 89-12 is referred to in almost every
dom estic LLC private letter ruling. But, even though Rev. Proc. 89-12 is procedurally capable of addressing LLC
classification issues, fundamental differences in the nature of LLC's and limited partnerships suggest that rulings
in this area would be improved by the issuan ce of a separate revenue procedure for LLC's, or a modification of
Rev. Proc. 89-12 to directly address LLC concerns. For example, consider the minimum capital account
requirements of Section 4.03 of Rev. Proc. 89-12 -- the pro vision applie s only to gen eral pa rtners and presum ably
is related in some way (although not expressly) to the test for limited liability, which most LLC's will concede.
Until the Service issues additional rulings with safe harbors comparable to those found relating to limited
partnerships, the tax classification of LLC's is unnecessarily uncertain.

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VIII.
DETAILED, COMPARATIVE DISCUSSION OF LIMITED PARTNERSHIPS, LIMITED LIABILITY
COMPANIES AND S CORPORATIONS.
This Article IV is a comp arative discussion of limited partnersh ips ("L P'ships"), limited liability companies
("LLC 's") and subchapter S corporations ("S Corps"), against the factors listed in Section II.B., abov e. For each
factor, there is a brief summary at the beginning, followed by a detailed discussion.
B. FORMATION AND MAINTENANCE REQUIREMENTS.
The ease and expense of forming and maintaining the entity:
SUMMARY
L P'ship
Formation can range from a "standard" agreement to a highly-negotiated,
complex document custom-crafted to fit the parties' business needs.
Usually, there are no ongoing maintenance requirements, except to reflect
changes in the identity or address of GP's, unless the governing
jurisdiction h as an an nual filing o r fee requirement.
LLC
From a documentation standpoint, a hybrid between S Corp and L P'ship,
but comparable to L P'ship.
As with partnerships, can range from very simple to complex, expensive
and time-consuming.
S Corp
Except for the requirement to make an election, requires normal
corporation formation.
General corpora te maintenance requirements (annual meetings, corporate
formalities), but VIP need to ensure that no non-qualifying persons
become shareholders.
Winner:
For pure simplicity, S Corp , if there is a "plain vanilla" busin ess deal,
with fixed ow nership and management (i.e. if the business deal do esn't
require a complicated buy-sell or other shareholders' agreement).
However, the range for any of the three forms is from quite lengthy
and complicated docu menta tion to a standard, off-the-shelf mo del.

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2. Limited Partnerships.
b. Certificate of L imited Partnership.
(2) Basic Req uirem ents.
To become qualified as a limited partnership, a partnership must file a certificate of
limited partnership with the Secretary of State or equivalent office of the state of formation. Under RULPA and
similar modern statutes, the certificate must include only very limited information:
(a) Name. The name of the lim ited pa rtnersh ip (which typ ically m ust contain
the words "L imited Partnership ," "Limited," or the abbreviations "L.P." or "L td.," as the last words o r letters
of the nam e, and m ay not contain the nam e of a limited partner who is not also a general partner);
(b) Address - Registered Office. The address of the registered office and the
name an d address of the registered agent in the state of formation for service of process;
(c) Address - Principal U.S. Office. The address of the principal office in the
United States where records are to be kept for inspection purposes;
(d)
of each general partner; and
(e)
General Partner Information. The name, and the mailing and street address
Other. Any other matters the general partners desire to include.
(4) Effect of Non-Compliance.
If there is a defective filing, unless there is "substantial compliance" (whatever that
means) with th e requ irements for the filing of the certificate of limited partnership, the partnership may be treated
as a general partnership, thereby exposing limited partners to personal liability for the partnership's obligations.
Note that the Texas statute contains a unique provision allowing a would-be limited partner caught by a defective
filing to file a statement that it believed that it was a limited pa rtner. That filing pro tects the perso n from liability
for up to 180 days (TRLPA §3.04); thereafter, further action, such as filing a suit, is required to continue th e
protection. TR LPA §3.04(b).
d. Execution.
The original certificate of limited partnership must be signed by all general partners. Unlike
under the ULPA requirements, RULPA and other modern limited partnership statutes do not require limited
partners to be named in or to execute the certificate. The limited partnership commences either when the
certificate is filed w ith the d esignated sta te filing office, and the filing fee is paid, or at a later date specified in the
certificate.
f. Maintenance -- Amendment.
Only a few events -- including (i) the admission of a new general partner, (ii) the withdrawal
of a general partner, (iii) a change in the name of the lim ited pa rtnersh ip or (iv) a change in the registered office
or name or address of the registered agent -- require the amendment of the certificate of limited partnership. The
amendment is required to be filed within 30 days of the ev ent. A lso, the general partner must promptly file an

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amendment if the general partner becomes aware that a certificate is false in any material respect, but has no
liability if it files the amendm ent w ithin 30 days after it first has or should have had knowledge of the material
falsity.
h. Limited Partnership Agreement.
Unlike statutes governing general partnerships and joint ven tures, RUL PA an d other m odern
limited partnership statutes require that the partners enter into a partnership agreement, but the agreement may be
oral. See, e.g., TRLPA §2.01. However, certain essential terms of the partnership agreement, such as the
allocation of profits and losses and the sharing of distributions, must be in writing or they will be governed by the
statute, as a fallback.
Although the limited partnership agreement can be combined with the certificate of limited partne rship, it
usua lly isn't, because the partners don't want the terms of their internal agreement to be made public via the
certificate. Also, inclusio n of unnec essary items in the certificate increases the chances that a change will occur
with respect to one, which increases the general partner's "no false certificate" burden (see paragraph c., abov e).
Filing a combined document was common under ULPA, where many more things were required to be in the
certificate to validly be part of a particular partnership, but can be expected to be very rare under modern statutes.
j. Statement of Purpose.
In a limited partnership, there can be competing considerations between the general and limited
partners regarding the statement of purpose:
LP 's - On the one hand, there may be tension between the limited partners' wanting some control over
the scope o f the gen eral partner 's free dom to ac t (ofte n, w ith th e lim ited partners' mone y!) a nd the g ene ral partner's
desire, or need, for a free hand to conduct the partnership's business.
GP's - On th e othe r hand, the g enera l partne r may wa nt the purpose to be narrowly defined so the
general partner may more safely engage in independent business activities in the same industry without fear of
improperly competing with the partnership in violation of its duty of loyalty.
4. Limited Liability Companies.
b. Articles of Organization.
The organization requirem ents under a state's L LC statute to form an LLC a re typic ally
com parab le to the requirements under the state's Business Corporation Act to form a corporation. In Texas, for
example, the required filing is of an LLC's Articles of Organization ("Articles"), which are sim ilar and functionally
equivalent to, a corporation's articles of incorporation.
Article 3.02 of the TLLC Act requires the Articles to contain the follow ing items (a fairly typical list):
(2) Name. Name of the LLC.
(4) Term. The period of the LLC's duration (original statute impo sed maximum term
of 30 yea rs; recent amendment allows perpetual term, but the term m ust be stated).

SAW - 16
(6) Registered Agent. The n ame and address of its registered ag ent.
(8) Management Authority. Names an d addresses of the initial manager or m anagers,
if management authority is to be placed with one or more managers, and a statement of that fact. If, on the other
hand, management is reserved to the members, the names and add resses of the m embers must be included. (As
discussed above, "TAX CLASSIFICATIO N," Article III., and in Section G., below , vesting man agem ent in
managers (even when they are members) currently results in the LLC's having the corporate characteristic of
centralized m anagem ent).
The Articles may contain other provisions that the organize rs desire to include relating to the LLC's internal
affairs, so long as not inconsistent with other law.
Article 2.03 of the Texas TLLC Act, as recently amended, requires that a Texas LLC's name contain one
of the follo wing : (i) "Lim ited Liability Company," (ii) "Limited Company," (iii) "L.L.C." (this natural abbreviation
was just add ed), (iv) "LL C," (v ) "LC ," or (vi) "L.C ."
d. Operating Agreement or Regulations.
An LLC is allowed by the enabling statute, but is not required, to adopt an operating agreement
(in Texas, the term "regulations" is used for the same functional document) governing operation and management
of the LL C. The operating agreement may contain any provisions for the regulation and managem ent of the affairs
of the LLC that are not inconsistent with law or the Articles.
In one sense, the operating agreement serves the same purpose as the bylaws of a corporation; however, they
really are more analogous to a limited partnership agreement. In fact, the "fallback" or "default" provisions of
many LLC statutes are modeled after, and therefore are very similar to, the fallback provisions of the state's limited
partnership statute. Likewise, many of the sam e subjects that can be modified w ithin a lim ited pa rtnersh ip
agreement under the state's limited partne rship statute may be m odified in the L LC's operating a greem ent. (Note
that not all states allow the same degree o f flexibility in the op erating agreement.)
For example, among the things that many LLC acts allow to be controlled by the operating agreement are:
(i) indemnification of managers and officers; (ii) requirements for admitting a member after the LLC has been
formed; (iii) limitations on assignment of a membership interest; (iv) the manner in which distributions are to be
shared; and (v) specifications of events that will cause a dissolution.
The initial operating agreement of an LLC usually is adopted by the manager or managers named in the
Articles, or by the members (if management has been reserved to the members, as allow ed in most states). The
mem bers (who need not be managers) may thereafter repeal or modify the operating agreement or adopt a new
one. The operating agreement may provide that m anag ers can not alter, amend o r repea l the op erating agree ment,
either in who le or in part (as described in the operating agreem ent).
Most real estate owners who otherwise would have used a limited partne rship, and their cou nsel, typica lly
will spend considerable time drafting and adopting customized regulations to fit the particular business
relationship. Care must be taken, however, to count corporate characteristics, because taking advantage of the
flexibility offered in a particular area may cause an L LC to have a corp orate c harac teristic that it otherwise wo uld
not have . Therefore, the flexibility offered by many LLC statutes should not be blindly enjoyed. See the detailed
discussion in Article III., above, "TAX CLA SSIFIC ATIO N."

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6. S Corporations.
b. Req uirem ents.
In additio n to the form ation re quirements for regular, or "C" corporations (e.g. filing Articles
of Incorporation, paying initial franchise taxes and filing fees, adopting bylaws, etc.), several requirements must
be met and maintained to ensure S Corp status, including the following:
Special S Corp Limitations
! The corporation must not be a member of an affiliated group;
! The corporation may not have more than 35 shareholders at any one time;
! The corporation may not ha ve shareho lders w ho are not in dividu als or who are
non-resident aliens; and
! The corporation may not have more than one class of stock (although differences
in voting rights are p ermitted).
These restrictions must be kept in mind (and relevant facts obtained from the client) when the various en tities are
being evaluated. In so me cases (e.g. when a parent/subsidiary relationship or foreign ow ners are involved), an S
Corp cann ot be u sed. B ecau se transfers to n on-q ualifyin g shareholders w ill cause the election to lapse, it is crucial
to disallow (generally through a shareholders' agreement) those transfers.
d. Election Procedure.
A corporation may elect S Corp status for a current year at any tim e during the prior tax able
year or at any time on or befo re the 15th day of the third m onth of the corporation's current tax year. The election
is made by the co nsen t of all shareholders and the filin g of IR S Fo rm 2 553. Failing to timely make the election
may result in an unanticipated "conversion," with attendant, undesirable tax consequences. (See paragraph c,
imm ediately follow ing.)
f. Conversion.
A corporation converting from C Corporation to S Corp status is not subject to tax on the
conversion but may be subject to a corporate level tax on the sale or disposition of an asset that was held on the
effective date of its election and had a fair market value in excess of its tax basis at that time ("a built-in gain").
This tax may be imposed on any built-in g ain for a period of ten years after the conversion.
Similar issues exist regarding contribution to or distributions by an S Corp (or C Corporation) of properties
with built-in gain. By comparison, property is m uch m ore ea sily contributed to and distributed from a partn ership
or an LLC on a tax-free ba sis. See the brie f, com parativ e discu ssion b elow at Section H. "Getting The Value
Out."
D. EXTENT OF LIABILITY.

SAW - 18
The extent to which the owners are liable for the obligations of the business is usually a controlling issue
in choosing the entity:
SUMMARY
L P'ship
LP's have no liability unless they participate in the control of the
partnersh ip in certain circumstances; but, L P'ships are required to have
a GP with unlimited liability.
With some potential tax implications, the liability problem can be
structured around by having an entity, such as a corporation or an LLC,
as the GP.
LLC
Generally, same liability insulation as corporate shareholder.
Better than L P'ship because there is no requirement to have a GP.
S Corp
Absent a "piercing the corp orate veil" situation, shareholders generally
have complete insulation from liability.
Winner:
Slight edge to S Corporations and LLC's, but quite manageable for
L P'ships.
2. Limited Partnerships.
b. Limited P artners.
Absent a contractual im position of liability, (e.g., a guaranty), limited partners generally are
not personally liable for the obligations of a limited partnership. Indeed, one of the key attractions of the limited
partnership form is the limitation of the liability of a limited partner to its capital contribution to the limited
partnership, plus any cash or property the limited partner agrees in writing to contribute. Limited liability may be
lost, how eve r, if (i) th e lim ited partner 's surname appears in the partnership name or, (ii) in the absence o f certain
protections, if the limited partner actively take s part in man aging the bu siness of the lim ited pa rtnersh ip. See, e .g.,
TRLPA §§3.03(a), (d).
(2) First Layer of Protection -- Safe Harbor. Most modern limited partnership statutes
(see, e.g., RULPA § 3.03(b)) contain "safe harbor" provisions defining rights and actions that will not subject a
limited partner to liability as a general partner, including:
or of a general partner,
(a)
(b)
consulting w ith and advising a general partner,
acting as a contractor for, or an agent or employee of, the limited partnership

SAW - 19
(c) proposing, approving, or disapproving certain matters relating to partnership
business (in some states, e.g. TRLPA §3.03(b)(8)(K), this includes a very broad "any other matter stated in the
partnership agreement"), or
partnership .
(d)
acting as a surety for, or guaranteeing specific obligations of, the limited
Note: These safe harbor provisions, especially in states like Texas and Delaware,
allow the partners to give a very broad management role -- which, in fact, can approach
complete control -- to one or more limited partne rs, without endang ering th e partn er's
limited liability.
(4) Second Layer of Protection -- Creditor Reliance. Even if the pa rticipation in
management by a limited partner whose name is not part of the partnership nam e exceed s the defined "safe
harbors," the limited partner will maintain limited liability except to third parties dealing with the limited
partnership who (i) have actual kno wled ge of the lim ited partner's participation, and (ii) at the time of the
transaction and b ased on the limited partne r's conduct, re ason ably b elieve that the limited partner is a general
partner. See, e.g., TR LPA §3.03(a).
d. General Partners.
A general partner of a limited partnership has the same personal liability for the limited
partnership 's obliga tions as a gen eral pa rtner in a general partnership. Nevertheless, using a corporation or an LLC
to be th e gen eral pa rtner effective ly limits the personal liability of any individual to the individual's investment
in the partnership or general partner. If the general partne r does not h ave a separate identity or is insu fficiently
capitalized, how ever, th e limited partnersh ip may ha ve the corporate c harac teristic of lim ited liability. This
increases the pressure to avoid two of the other corporate characteristics, to maintain partnership tax treatmen t.
See th e "TA X C LASSIF ICA TION" d iscussion at Article III., above.
4. Limited Liability Companies.
b. Gen erally.
The liability of a member or manage r of an LLC is com parab le to that of a co rporate
shareholder. Therefore, the general ru le is that LLC members and managers are not liable for the debts, obligations
or liabilities of an LLC, including under a judgm ent decree, or order of a court. See, e.g., TLLC Act Art. 4.03.
In som e states, th e ope rating a greem ent of th e LLC m ay specifically provide fo r a different result.
The exceptions, as with the promised contributions of limited partners to a limited partnership, impose on
a member of an LLC perso nal liability to the LLC to perform any e nforceable com mitm ent to contribute cash or
prop erty to or to perform services for the LLC. In some states, enforceability requires a written commitment. That
obligation can be waived by the consent of all members, or the operating agreement of the LLC may provide for
relaxation of the obligation, but those compromises are not binding on a creditor who extends credit to the LLC
in reliance on th e me mber's com mitm ent to m ake th e con tribution . See, e.g., TLLC A ct Art. 5.02. Also, in an
insolvency context, a member may be obligated to repay any distribution received if the member knew of the

SAW - 20
insolvency, which is the same result under TRLPA §6.07 for distrib utions to a lim ited pa rtner. TLLC Act A rt.
5.09.
d. Interstate Activities of An LLC; Extraterritorial Application.
A key open issue involving use of the LLC form is the extent to which the limited liability of
mem bers will be respected when the LLC cond ucts business in states that have not adopted an LLC statute. The
fear is that the fallback position in those states will be to treat the members as general partners in a general
partnership, with each having joint, or joint and several (depending on the particu lar state's g enera l partne rship
rules), liability for the de bts and obligations of the LLC. Fortunately, the problem sho uld be diminishing -- almost
eighty perce nt (80%) o f the U .S. states have now adop ted LL C legislation a nd the othe rs are consid ering it.
f. Doing Business In Other States -- Planning Ideas.
Comm entators have offered a number of structural planning ideas intended to overcome the
unce rtainty of limited liability treatment in a state without an LLC statute, but each has one or more potential
drawback s. For example, one has suggested that an LLC register as a foreign corporation in states that do not
legislativ ely recog nize L LC's. The th ought is that th e registration w ould serve as notice and some authority to treat
the LLC as a corporation (with limited liability for its owners) in that state. However, it simply may not be
possible to meet the qualification requirements of any given state, and there certainly is no guaranty that the
registration would bind creditors to LLC limited liability treatment of the members.
h. Piercing The V eil.
As described in the following Section 3.b., courts have developed a body of law allowing them
to "pierce the corporate veil" to disregard the limited liability of shareholders of a corporation . It is conc eivab le
that, for an inadequately capitalized LLC, a similar approach will be taken. That prospect should be monitored.
6. S Corporations.
b. Shareholders.
The key re ason for choosin g to op erate in corporate fo rm is th e availability of limited liability
to the shareholders. Usually, the liability of shareholders is limited to their investment in the S Corp.
d. Piercing The C orpo rate V eil.
Cou rts have deve loped a bod y of law that allows them to "pierce the co rporate veil" to disregard
the limited liability of share holders. Co urts loo k prim arily at the fo llowin g three factors to determine wh ether to
pierce the co rporate veil:
(1) the failure to observe corporate formalities;
(2) the domination of the corporation by a controlling shareholder; and
(3) undercapitalization of the corporation.
In most cases where the corporate veil has been pierced, the corporation has been used for an improper purpose,
and fraud or bad faith is involved.

SAW - 21

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F. MANAGEMENT AND CONTROL.
The extent of participation in managemen t and control desired by the ow ners:
SUMMARY
L P'ship
Management is by the GP's or, frequently, a single Managing GP.
However, there is great flexibility to alloca te mana gemen t authority
among all partners, including LP's (although, to avoid liability concerns,
some care must be taken in the case of LP's).
LLC
Flexible alternatives to manage through managers (who need not be
members), or to reserve management to members, or a combination. But,
there are tax classification issues to consider if done through managers.
There are no liab ility concerns resulting from the mere fact of member
participation in ma nagem ent.
S Corp
Normal corporate management structure: board of directors, officers, etc.
Shareholders can be involved as board memb ers and/or officers, generally
without fear of liability.
In more com plicated situations, a voting agreem ent or other shareh olders'
agreem ent may be necessary to regulate the co rporation 's managemen t.
Winner:
No clear winner -- offsetting pluses and minuses with each.
2. Limited Partnerships.
b. Gen erally.
(2) Control V ested in General Partners.
Because the control of a limited partnership is vested in the general partners,
management tends, in a sense, to be centralized. For federal income tax pu rpose s, how ever, a limited partne rship
organized und er RULPA or a similar statute generally does not have the corporate characteristic of "centralized
manage ment." The theory is that the gene ral partn er is acting in its own behalf, as well as for the limited partners.
But, as discussed in detail in Article III., abov e, the IR S will not giv e an advanced ruling that centralized
management does not exist (i) if the general partner owns less than a 20% interest in the limited partnership or
(ii) the limited partners have an unrestricted right to re move the gene ral partn er. See , "TA X C LASSIF ICA TIO N,"
abov e, Article III..
Except as lim ited by statute o r by the partn ership agree ment, the g enera l partne rs in a lim ited pa rtnersh ip
have the powers of a partner in a general partnership. See, e.g., TRLPA §4.03(a). Limited partne rs ma y lose their
limited liability if the y activ ely pa rticipate in ma nage ment (except as allowed under the safe harbo r provisions of,
e.g., TRLPA §3.03(b), including the potentially very broad Section 3.03(b)(8)(K) discussed above, and subject

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in all cases to the reasonable reliance limitation imposed on creditors). Under modern limited partnership statutes,
all partners and their assignees, acting directly o r throu gh representatives, have a bro ad righ t of access to
partnership books and records and other information regarding the affairs of the partnership. See, e.g., TRLPA
§1.07.
(4) Classes of V oting R ights.
The partnership agreement may establish various classes or groups of limited partners
having various rights, powers or duties, including voting rights. See, e.g., TRLPA §3.02.
d. Fiduciary Obligations.
(2) Limited P artners.
Generally, limited partners do not have fiduciary obligations to each other or to the
general partners. It is conc eivab le, how ever, th at a limited pa rtner given b road man agem ent righ ts und er a statu te
like TRLPA §3.03(b)(8)(K) has fiduciary du ties.
Note: A safe harbor like TRLPA §3.03(b)(8)(K) that allows limited partners to, in a
sense, "act like general partners," raises the issue of the standard of conduct to be applied
to a limited partner who permissibly exercises such control. Does the limited partner have
the same fidu ciary duty to the other partners a s a general partner? One could resp ectably
argue that it should. A well-drafted partnership agreement should speak to the issue,
whether to state that the limited partners have no fiduciary duty to the other partners or that
they have the same fiduciary duty as a general partner. Q uery wh ether pub lic policy could
be invoked to strike down a provision absolving a "controlling" limited partner from any
fiduciary duty to the other partners.
One could seek to limit the fiduciary duty of a limited partner -- and, perhaps, to preempt a court's taking
a contrary position -- by stipulating in the partnership agreement itself that the limited partner is not liable for
actions "not opposed to" the interests of the partnership. On the other hand, if the limited partners are passive, the
agreement might state generally that the limited partners have no fiduciary duties to one another or to the general
partners.
(4) General Partners.
Like partne rs in a genera l partne rship, th e gen eral pa rtners in a limited partnership owe
to each other and to the limited partners fiduciary duties of good faith, loyalty and due care.
(a)
Between Partners.
General partners at least, are fiducia ries to ea ch oth er with respect to partnersh ip
business and, a ccord ingly, m ust act w ith loya lty, goo d faith, fa irness a nd hones ty in de aling with each other.
These fiducia ry obligation s proh ibit partn ers from using partne rship a ssets for their ow n ben efit, com peting with
the partnership, usurping business opportunities of the partnership, or using confidential information for personal
advantage. Latter v. Kilbou rn, 150 U.S. 524 (1893). State common law typica lly requ ires partners to disclose all
material facts known to them that relate to partnership affairs. For example, the court in Johnson v. Buck, 540
S.W.2d 393 (Court App. - Corpus Christi 1976), citing to the 1938 Texas Sup reme C ourt case of Johnson v.
Peckham, 120 S.W.2d 786, sum marized the duty as follows:

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It is a rule of long standing that each partner in a partnership business is a confidential agent of the
other partner, and each is required to make full disclosure of all pa rtnersh ip facts know n to him with
respect to partnership affairs.
Johnson v. Buck, at 399.
A partner must account to the partnership and hold as trustee for the partnership any benefits or profits a
partner derive s, without the consent of o ther pa rtners, fro m the form ation, conduct, or liq uidatio n of the partn ership
or from the partner's use of assets of the partnership. UPA § 21(1)
[Note: The only use in UPA of the term "fiduciary" is in the title of this Section: "Partner Accountable
as a Fiduciary".]
(b)
Pre-Formation.
Although the law in many states is not very well-developed on the issue, in some
states prospective partners apparently do not owe each other fiduciary duties during pre-formation negotiations
leading to the creation of a partnership. See, e .g., Reyes-Retana v. PTX Food Corp., 709 S.W.2d 695, 697 (Tex.
App. -- San Antonio 1986, writ ref'd n.r.e.) (holding that no fiduciary duty existed among parties agreeing to form
a partnership because no partnership existed when the challenged transactions took place). There is a split of
autho rity in othe r jurisdictions. S ee BRO MB ERG AN D R IBSTEIN , §§ 6.0 6, 6.07 , at 6:62-63, 6:72-73. The
general law of fraud and deceit may, however, apply . See, e.g. Chien v. Chen, 759 S.W .2d 484, 495 (Tex . App. --
Austin 1988, no writ) and BROMBERG AN D RIBSTEIN, § 6.06, at 6:63.
(c)
Rationale.
Fiduciary duties are owed by partners to each other largely because the parties
have joint and several liability for partnership debts and because their mutual agency relationship enables any
partner to bind the partnership (and the jointly and severally liable other partners) to obligations created by the
partner within the scope of the partnership's business.
4. Limited Liability Companies.
b. Choo sing Managers.
An LLC's affairs are handled by its managers, unless the LLC's operating agreement reserves
all or part of the management authority to the members. See, e.g., TLLC Act Art. 2.1 2. Reservation to the
mem bers is much more likely and manageable in an LLC with few members, who all desire to be active in the
business (and, as noted be low, h elps to avoid havin g the c orpo rate ch aracteristic of centralized management. The
managers are functionally equivalent to (i) the directors of a corporation and (ii) the m anaging partners of a
partnership, except that the managers do not have to be owners.
The number of initial managers is fixed by the Articles; thereafter, the number is fixed by and as provided
in the regulations. The managers are elected annu ally by a vote of the mem bers. See, e.g., TLLC Act Articles
2.12-2.13. The managers may be divided into classes with staggered terms, if provided in the regulations. Unless
the regulations require it, the managers need not be either state of formation residents or members of the LLC.

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Note: Current IRS rulings provide that management through managers gives the LLC the corporate
characteristic of centralized management. This is discussed in more detail in the "TAX
CLAS SIFICATION" provisions of Article III., above.
d. Action B y Managers.
Many LLC statutes allow the managers considerable flexibility in conducting the LLC 's
business. In those states, such as Texas, the regulations (or operating agreement) are the blueprint, with the
enabling statute providing "fallback" rules where the operating agreement is silent. A typical statutory fallback
is action by a majority vote at a meeting attended by a majority of the managers. See, e.g., TLLC Act Art. 2.16.
Other states, e.g . Colo rado, require that man agem ent be cond ucted by m anag ers (w hich p robably co ntributed to
the unfortunate conclusion of Rev. Rul. 93-6, discussed above in Article III.).
Also, the statutes vary in the level of statutory detail. For example, the TLL CA conta ins considerable d etail,
authorizing the establishment of committees, establishing quorum requirements and dealing with appointment of
officers. On the other hand, the approach of the ULLCA is to leave the details for coverage in the operating
agree ment.
f. Individual Authority To Bind LLC.
LLC statutes are fairly sp ecific in describing the categories of person s wh o can create
obligations and d ebts binding on the LLC. Essentially, it's a matter of authority, which can reside in the following
places, subje ct to variation b y the a rticles or operating a greem ent:
or managers;
(1) One or more m anag ers, if management has generally been vested in a manager
(2) A m ember or members, if management is retained by the members; or
(3) Any officer or other agent who has actual or apparent authority.
E.g., TLL C A ct Art. 2 .10. U nless th e auth ority to a ct was given co-exten sively to more than one of these groups,
the exclusive authority to act on behalf of the LLC would reside within the category to which management has
been given or reserved.
h. Rights of Members - Voting.
The rights o f members to vote on LLC matters have characteristics of shareholder and limited
partner rights. The m embers may vote on an y LLC matter prov ided in the articles or op erating agreement,
including the election of managers at the annu al me eting of members. Among other things, the operating
agreement may p rovide for class v oting by m embers, entitling them to elect one or m ore managers. See, e.g.,
TLLC Act Art. 2.13.
As with the TBCA and the TRLPA, the TLLC Act allows the creation of one or m ore classes or groups of
mem bers having various rights, pow ers and duties, includ ing voting rights. T he reg ulation s (ope rating a greem ent)
may provide for the future creation of additional classes or groups of m embers having rights, powers, or duties,
even if senior to thos e of ex isting cla sses or grou ps of m embers. T LLC Act A rt. 4.02. Also, the operating
agreement may conta in provision s gov erning the e xercise of vo ting righ ts, including waiver of requirements,
actions by consent without a meeting and proxy and q uorum requirements.

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j. Fiduciary Obligations.
LLC's are too new to make definitive statements about the application to m embers or managers
of fiduciary duties. However, one can certainly make an educated prediction, and that's what is attempted here.
(2) Mem bers.
It is likely that members who are not man agers will have no fiduciary duties, as gen erally
is the case with passive limited partners. (See the discu ssion at subparagraph b.(1), above.) Mem bers who are
managers, on the other hand, may have fiduciary duties to the other members. In this status, a member/manager
is a hybrid between a general pa rtner, and a limited partne r autho rized to particip ate in management, with perhaps
a slight lean toward the general partner end of that continuum. Therefore, the argument made in subparagraph
b.(1), abov e, that lim ited pa rtners in volved in m anag ement co uld be exp ected to hav e fiduc iary du ties, wo uld
apply.
(4) Man agers.
Man agers who are not members should have the same fiduciary duties as managers who
are members, and are fun ctiona lly much like corporate directors and officers. The precise nature and extent of the
duties will, perhaps, be defined by future case law.
(6) Legislation.
Second-generation LLC statutes will likely address the fiducia ry responsibility issue.
For example, the draft ULLCA generally follows the model of RUPA, imposing on m anagers (w hether m embers
or not) the duties of loyalty, care and good faith, and providing that those duties can't be waived (although
standards by which performance of the duties is measured can be established, if not manifestly unreasonable). In
states that adopt a statute comparable to RUPA , but which do not address LLC fiduciary issu es directly, it is
reasonable to con clude that the courts of that state w ill look to the RUPA-eq uivale nt as a m odel.
Under U LLCA , memb ers who are not managers w ill have no fiduciary duties.
6. S Corporations.
Like the shareho lders of a C C orporation, shareholders o f an S Co rp may participate in the
management and control of the business, without endangering their limited liability. The shareholders of an
S Corp are not restricted in their participation as officers or directors of the S Corp.

SAW - 27
H. TRANSFERABILITY OF INTERESTS.
The extent and ease by which an ownership interest in the entity may be transferred, an d any undesirable
consequen ces:
SUMMARY
L P'ship
Transfers of a GP 's interest can cause dissolution and, therefore, typically
are restricted by contract. Such a restriction also helps on the "free
transferability of interests" tax classification issue.
Transfers of an LP's interest does not cause a dissolution concern.
Distinction between transfer of economic rights and tran sfer of partner
status, including (particularly for GP's) management rights.
Because of fiduciary duties and other personal relationships, and
partnersh ip tax classification concerns, transferability and the right to
become a substituted partner are usually restricted.
LLC
S Corp
Same general concerns as with L P'ship.
Subject to securities laws issues and contractual limitations among the
shareholders, shares are freely transferable.
Free transferability creates a concern regarding p otential tran sfers to
non-qualifying shareholders, which typically results in contractual
limitations among the shareholders.
Winner:
Limited partnerships -- currently treated less restrictively than LLC's;
S Corp shares are legally freely transferable, but contractual
limitations usually are imposed.
2. Limited Partnerships.
b. Assignment by Limited Partner.
Unless the partnersh ip agre ement pro vides otherw ise, the e cono mic rig hts of a limited partner --
the limited partner's share of profits and its share of the assets on dissolution -- may be assigned without the prior
consent of other partners and without triggering dissolution. The assignee has no liability as a partner unless the
assignee has become a substituted limited partner, which requires the approval of all other partners or an enabling
provision in the partnership ag reemen t. See, e.g., TRLPA §7.02(a)(4).
d. Assignment by General Partner.
The assignment provisions of RULPA (§702) also apply to general partners. The Texas
counterpart has a unique provision that gives the limited partners, by the vo te of a m ajority in interest of the limited

SAW - 28
partners and in the absence of a co ntrary provision in the pa rtnersh ip agre ement, the right to te rminate the general
partner status of a general partner w ho assigns all rights as a general partner. TRLPA §7.02(a)(4).
f. Certificates of Partnership Interest.
To facilitate transferability, so me modern limited partne rship statutes (e .g., TRLPA §7.02(c))
provide that a partnership interest may be evidenced by a certificate of partnership interest. Th ese certificates are
especially usefu l in large p ublicly -held partne rships to provide liq uidity to a limited partnersh ip interest, making
it more attractive to investors.
h. Tax - Corp orate C harac teristic.
An RULPA limited partnership lacks free transferability of interests (one of fou r key corporate
characteristics, two of which must be avoided to ensure partnership federal income tax treatm ent), unless partners
owning substantially all of the interests in the partnership have the po wer, without the consent of other partners,
to substitute for themselves in the partnership a person who is not a partner. Treas. Reg. Section 30 1.7701-2(e)(1).
The IRS has recently announced that it generally will rule that a partnership lacks free transferability of interests
if, throughout the life of the partnership, the partnership agreement expressly restricts (within the meaning of
Treas. Reg. §301.7701-2(e)(1)) the transferability of partnership interests representing more than 20% of all
interests in partnership capital, income, gain, loss, deduction, and credit. Rev. Proc. 92-32, 1992-18 I.R.B. 28
(April 27, 1992).
VIP Note: Thus, even though modern limited partnership statutes allow a limited
partnersh ip agreem ent to give a n assigno r the unilateral right to admit its assignee into the
partnersh ip as a new limited partner, such a provision should not be included without first
assuring either that more than 20% of the other interests are restricted or that at least two
of the other three corporate characteristics have been avoided.
4. Limited Liability Companies.
Following the lead of sister limited partnership statutes, LLC statutes generally allow the free
assignment of only econom ic rights, but not managem ent rights, and do not automatically confer member status
on the assignee. Rather, the assignor continues to be able to exercise all rights, including voting rights, that have
not been assign ed, un til the assig nee is admitted as a member in the manner provided in the operating agreement
or on the consent of all other members. As w ith many limited partnership statutes, some LLC statutes are flex ible
enough to enable the LLC's constituent documents to permit free transferability of economic and management
rights.
Therefore, the free transferability advantage of operating in corporate fo rm can be obtain ed w ith an LLC
by writing the operating agreem ent to accomplish the desired freedom. However, as noted above, there are critical
federal tax classification issues that m ust be taken into account. Don 't blindly or blithe ly take adva ntage of this
freedom -- count the characteristics.
6. S Corporations.
No direct restrictions are imposed on the transferability o f stock in an S Corp. As a practical matter,
however, freedom to transfer is lim ited by the rules governing eligible S C orp shareh olders -- certain transfers

SAW - 29
might violate the 35-shareholder limit or result in an ineligible person (such as a corporation or a non-resident
alien) becom ing a shareh older.

SAW - 30
J. LEGAL FLEXIBILITY.
The extent to whic h the a ctions of the o wners of th e business a re governed an d limite d by law (a nd their
ability to contractually vary that result) and the ease with which the form of business can be changed:
SUMMARY
L P'ship.
In most ways, enormously flexible -- largely a matter of contract among
the partners, with the statute serving only as a fallback.
However, care must be taken to count corporate characteristics (such as
free transferability, which the partners are allow ed to create by contract,
but which can endanger partnership tax treatment) when deciding how
much of the freedom to use.
[Tax basis and related items are discussed in Section G., below.]
LLC
Genera lly, same analysis as for partnersh ips; but, so far the IRS has not
treated L P'ships and LLC's exactly the same in the partnership tax
classification area (allowing somewhat less flexibility on certain issues for
LLC's).
[Tax basis and related items are discussed in Section G., below.]
S Corp
Much less flexibility than with the other forms of ownership.
The limitations include inability to have corporate or nonresident alien
owners; tax basis available only for contributions and loans to the
corporation, but not for the shareh olders' perc entage sh are of corp orate
loans; and, inherently less flexible corporate structure.
Winner:
Slight edge to L P'ships over LLC's (because of IRS anomalies), but
both are enormously flexible.

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2. Limited Partnerships.
Most provisions of modern limited partnership statutes can be altered by contra ct, giving particip ants
significant flexibility in structuring the entity. Among other things, under the more flexible statutes, the
partnership agreement may:
! Establish multiple classes or groups of limited or general partners having various rights,
powers or duties, including voting rights (see, e.g., TRLP A §§3 .02, 4.05).
! Alloc ate profits a nd losses, an d dete rmine distributions , with th e statute servin g only as
a fallback.
! Stipulate conditions for admission of a new limited partner after formation (otherwise,
all must consent).
! Modify events of withdraw al of general partner.
! Impose liability on a partner for contribution obligation and specify consequences of
non-payment.
! Specify circum stances under w hich a partne r is entitled to a distribution before
withdrawal and before partnership liquidation.
! Provide for continuation of the business after dissolution.
! Allow a partner to adm it an assignee as a substituted partner.
These are on ly a few of the m any a reas w hich th e statute allows to be co ntrolled by the limited partne rship
agreement. There is great flexibility.
4. Limited Liability Companies.
As with lim ited pa rtnersh ips, a key ad vanta ge to th e LLC form of ow nersh ip is flexibility. Generally,
the sam e flexibility available to limited partnerships is available to LLC's, through customized articles and
operating agree ments. As with limited partne rships, how ever, th e flexib ility can carry a potential tax classification
risk that must be carefully evaluated -- one cannot blindly take advantage of the statutory flexibility in certain areas
without risking the pa ss-through partne rship tax class ification that pro bably led to th e cho ice of th is entity in the
first place.
b. Statuto ry Flexibility.
The states vary considerably in the flexibility they allow the organizers and owners of an LLC
in structuring their intern al relationship . The W yom ing statute (the first LLC statute), and those which followed
it, are relative inflexible. These are sometimes called "bulletproof" statutes because their lack of flexibility, in part,
ensures that partnership tax status will not be lost because of failure to avoid the req uisite nu mber of co rporate
characteristics. Other statutes, such as Texas, Delawa re and the ULLCA, are more flexible, and are sometimes
referred to as "flexible bulletproof" statutes. For example, Rev. Rul. 93-38, 1993-21 I.R.B. 4, the Service
evaluated the federal tax classification of Delaware LLC's formed under the Delaware Limited Liability Company
Act, using the following example of two LLCs: (1) one LLC did not vary from the default provisions of the

SAW - 32
statute, and was fou nd to have only the co rporate characteristic of limited liability (wh ich, as n oted a bove, is
usua lly conceded); and (2) the second LLC took advantage of statutory flexibility to (A) vest management in three
managers elected by the m embers, (B ) allow an ass ignee to participate in management of the LLC and (C) provide
that the LLC continued after the termination of membership of a mem ber, and w as found to have all four key
corporate characteristics.
The point here is that where a flexible statute exists, the drafter has the freedom to choose to have one or more
corpora te characteristics. Where the flexibility is used, there must be careful counting of characteristics to avoid losing
partnersh ip tax treatm ent.
d. Tax Classification Concerns.
As noted imm ediately abo ve, it m ay no t be ad visable, at least fo r now , to take adva ntage of all
of the flexibility offered by man y LL C statu tes. See "TA X C LASSIF ICA TIO N," above, at Article III..
6. S Corporations.
In additio n to be ing su bject to the sam e una lterable state corporate laws as C Corporations, the tax
rules governing S Corps are mandatory and cannot be chan ged by agreement. As a result, S Corp s are not nea rly
as flexible as partnerships or LLC's.
Furthermore, S Corps can only have one class of stock (contractual "special allocations" are n ot allowed),
although differences in voting rights are allowed. As a result, preferences in interest in an S Corp can only be
achieved through co mpensation or debt a rrangements, or other more com plicated struc tures, a limitation that
severely reduces the entity's flexibility.
Finally, as noted above, tax basis is more difficult to obtain for an S Corp shareholder than for a partner or
LLC mem ber.

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L. CONTINUITY OF EXISTENCE.
The exten t to wh ich the own ers desire that th e entity have contin uity of existen ce can be im portant:
SUMMARY
L P'ship.
Partnership statutes, which control in the absence of a contrary agreement
among the partners, prevent perpetual existence. However, subject to tax
classification issues, virtually perpetual existence may be provided by
contract.
But, the absen ce of a perpetua l continuity of life is a positive factor in the
partnership tax classification area.
Therefore, if continuity of life is provided for, then the other three
classification characteristics must be examined more closely.
LLC
S Corp
Winner:
Governing statutes in different jurisdictions vary (e.g. some impose a
maximum term while others allow perpetual existence), but the
approp riate analysis is the same as for an L P'ship -- if existence can
continue perpetua lly, then one corporate characteristic is present and the
other three must be exam ined closely (and, w ith liability generally being
conceded, this leaves only two, both of which must be avoided to ensure
partnership tax treatment).
Typically, it has the perpetual existence of all corpo rations, bu t is subject
to loss of S Corp status if a non-qualifying party becom es a shareholder.
However, unlike L P'ships and LLC's, perpetual existence has no adverse
effect on federal incom e tax status.
If continuity of existence alone, with no hint of an adverse effect on tax
status, is desired, then S Corp wins. Generally, however, this is not
the most critical issue in the choice of entity a nalysis.
2. Limited Partnerships.
b. Events of Dissolution.
Generally, a limited partnersh ip is dissolved whe n the firs t of the following occurs: (i) a
dissolution event specified in the partnership agreement; (ii) written consent of all partners; (iii) withdrawal
(including death and bankruptcy) of a general partner; or (iv) entry of a decree of judicial dissolution. The death,
bank ruptcy or other w ithdraw al of a lim ited pa rtner or the assignm ent
of a limited partner's interest to a third party, however, does not affect the continuity of existence of the limited
partnership, unless the partners provide to the contrary.
d. Reconstitution.
After dissolution, a limited partnership may be reconstituted and its business continued without
winding up or termination if (i) there is at least one general partner remaining and the partnership agreement

SAW - 34
perm its the bu siness to be carried o n, or (ii) all of the partners agree in writing to con tinue th e business w ithin
90 days after dissolution and appoint one or more new general partners.
Importantly, som e limited partnersh ip statute s allow a limited partnersh ip to have a non-partner liquidator
after dissolution, with expressed insulation from liability as a gen eral pa rtner. See, e.g., TRLPA § 2.02(f), which
now also permits the ce rtificate of limited partne rship to be am ende d to identify the non-partner liquidator (which
gives the liquidator a great deal of comfort).
f. Tax - Corp orate C harac teristic.
One of the fo ur key corporate characteristic s in the ta x class ification area is "contin uity of life."
Basically, continuity of life will not be found to exist if the partnership dissolves on the death, insanity,
bankruptcy, retirement, resignation or expulsion of any of its general partners. Treas. Reg. §301.7701-2(b)(1).
Continuation in the manner allowed under Article 8 of RULPA will not cause there to be continuity of life.
Note that the IRS recently announced that it will not find that a limited partne rship h as the c orpo rate
chara cteristic of continuity of life if, under local law and the partnership agreement, the bankruptcy or removal
of a general pa rtner of a limited partnership causes a dissolution of the partnership unless the remaining general
partners or at least a majority in interest of all remaining partners agree to continue the partnership. Rev. Proc.
92-35, 1992-18 I.R.B. 21 (May 4, 1992). See Article III., above, "TAX CLASSIFICA TIO N," fo r a com plete
discussion.
4. Limited Liability Companies.
If the operating agreement adopted for an LLC is silent regarding continuation after a dissolution, then
under a typ ical LL C statu te (e.g., T LLC Act A rticle 6.01), and follow ing the limited partne rship m odel, th ere is
a dissolution on the first to occur of the following:
a. The period fixed for duration of the LLC expires;
b. The occurrence of events specified in the Articles or regulations;
c. Written consent of all mem bers;
d. The death, retirement, resignation, expulsion, bankruptcy, or dissolution of a member
or the occurrence of any other event that terminates the mem bersh ip of a m ember in the LL C, unless there is at
least one remaining member and the business of the LLC is continued by the con sent of the number of mem bers
stated in the articles or regulations or, if not so stated, by all remaining members; or
e. Entry of decree of judicial dissolution under Article 6.02.
Therefore, if the operating agreement is silent on continuation, the LLC would be wound up on dissolution.
Under current IRS positions, taken mainly in private letter rulings (see "TAX CLASSIFICATION ," abo ve, in
Article III.), continuity of life will be found not to exist only if an LLC's operating agreement (or the statute, if not
in the operating agreem ent) requires unanimous consent of all members to continue. If the operating agreement
specifies continuation by a majority vote (as the RULPA also allows), then under current IRS interpretations the
LLC will have continuity of life. As a result, the rules are more restrictive for LLC's than for limited partnerships
(for limited partnerships, continuity of life will not be found if the continuation under certain circumstances
requires a vote of all remaining general partners or at least a majority in interest of all remaining partners).

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6. S Corporations.
Corporations can h ave a perpetual existence. Unlike sole proprietorships -- and partnerships that do
not contractually provide for continuation after dissolution -- the removal, death or incapacity of a director, officer
or shareholder will not disrupt the continuity of the corporation.
Typically, the board of directors, together with a two-thirds vote of shareholders, or the shareholders alone
on unanim ous consent, may cause the dissolution of a corporation upon the filing with the Secretary of State of
articles of disso lution. See, e.g., TBCA, Part Six. Additionally, the charter of a corporation may be dissolved by
the state for failure to pay franchise taxes.

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N. TAX CONSIDERATIONS.
The tax treatment of the entity, its owners and employees is often the single most important factor in the
entity-choice decision. A number of the relevant tax issues have been discussed above, in Article III., "TAX
CLA SSIF ICA TIO N," and sprinkled through the other sections. There is a discussion of important tax issues, also,
in Section H., following.
SUMMARY
The desire of most real estate owners for partnership federal income tax treatment (usually coupled with a desire
for limited liability) leads to narrowing the choices of entity to the three discussed in detail in this paper.
L P'ship.
Ensuring partnership tax treatment by avoiding more than two of the four corpora te
characteristics (continuity of life, limited liability, free transferability of interests and
centralization of managem ent) is paramount.
Care, and giving up some of the available contractual freedom (e.g. not taking full advantage of
the ability to admit the transferee of a partner as a substituted partner), can ensu re partnership
tax treatment.
Also, although the allocations must have "substantial economic effect" (i.e. affect your
pocketbook, not just your tax bill), partners are free to specially allocate tax items among
themselves in ratios different from their basic ownership percentages.
Subject to certain limitations and prerequisites, partners may obtain tax basis (against which
deductions m ay be taken) for their percentage share of partnership indebtedness.
LLC
S Corp
Essentially, LLC's are treated the same as partnerships -- subject to a couple of stricter
limitations and requirements, they allow for very flexible, and favorable, federal income tax
treatmen t.
Partnership tax treatment results from (i) making the requ ired election and (ii) satisfying the
ownership requirements (e.g., no corporate or nonresident alien owners).
S Corps cannot make special allocations.
But, there are no concerns regarding counting corporate characteristics.
Winner:
Flexibility favors L P'ships and LLC's.
L P'ships have a slightly ea sier time of it in the characteristics/classification area; but, LL C's
have a potential tax basis advanta ge in qualifying for non-recou rse basis treatment for an
entity-recourse debt.

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2. Limited Partnerships.
Most partnership agreements drafted by counsel specifically cover the important issue of allocating
the federal income tax incidents of owing the real property. (Of course, not every effort to deal with allocations
is succ essful or correct, bu t it wou ld be u nusu al for the subject not to be co vered at all.)
b. Allocations v. Distributions.
One important point lost even on relatively experienced practitioners is the distinction between
allocations and distributions. These areas are clearly related, and an allocation often affects the amount of a
distribution ( and the tax laws now essentially require that), but they aren't the same thing. The allocation of tax
items typically would cover profits and losses and, in some cases, specific deductions. On the other hand, the
distribution provisions directly deal with how and when the cash or other assets of the partnership are distributed
to the pa rtners. If th e partn ers are sharin g eve rything on a "heads up" ba sis -- that is, strictly in accordance with
their profit-sharing percentages -- then neither the allocation nor the distribution provisions are complicated and,
in fact, can be very short. If, on the other hand, there are disproportionate "special allocations," then the allocation
prov isions often are quite lengthy and complicated (and require a tax expert's help). They also tend to include
numerous references to Internal Revenue Code or Treasury Regulations sections. (Limited partnership agreem ents,
where one seems more often to find investor partners who receive disproportionate tax allocations, often co ntain
"boilerplate" tax allocation provisions designed to apply if there ever are special alloca tions, ev en if no ne is
initially present or then conte mplated.)
d. Operations v. Liquidation.
As a general proposition, partners have much flexibility regarding allocations and distributions
during the operational period of a partnership, provided that at liquidation they "pay for" prior allocations, because
the tax laws require that allocations have "substantial economic effect" -- partners are not allowed to enjoy bene fits
(i.e., "paper" losses) vis-a-vis the tax collector without feeling the pinch in their wallets (i.e., "hard dollar" losses).
f. Statutory Provisions.
Because it is a much more modern statute than UPA (1985 vs. 1914), the RULPA, contains
"fallback" or "defa ult" allocation provisions in tende d to fairly reflect the partner's expectations, which today are
often heavily influenced by federal income tax considerations (e.g., when there's an investor to whom
dispro portionate allocations are made to "pay back" the investment). Because most written agreements have
allocation provisions, Section 503 of RULPA states that allocations are made in the manner provided by a written
partnership agreement. The statutory fallback provision, filling what should be a rare gap (i.e., one the written
agreement fails to cover), allocates profits and losses among the partners in accordance with the relative value of
the partners' unreturned capital contributions.
As a gene ral ma tter, if on a udit the Internal Revenue Service determines that allocations have been made
improperly, an adjustment may be required. This "correction" may have a material effect on the partners' business
expectations, and underscores the importance of the drafter's knowing the tax consequences of includ ing (or not)
certain provisions in the agreement. At a minimum, the drafter should be informed enough to advise the partners
if a requested allocation, from a business deal standpoint, would likely not be supported by the Service on an au dit.

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4. Limited Liability Companies.
Many of the relevant tax considerations are discussed in various places, above, including a detailed
discussion in Article III., "TAX CLASSIFICATION." The key points are summarized below.
b. Federal Income Tax Classification.
In additio n to allo wing any o r all own ers to participate in management without any individual
liability to third parties, LLC's are used to achieve partnership pass-through federal income tax treatment. As noted
imm ediately above in Section F., and in detail in Article III., this requires avoiding two of the four corporate
characteristics of (i) limited liability, (ii) centralized management, (iii) free transferability of interests and
(iv) continuity of life.
(2) Lim ited Lia bility.
As noted , the lim ited liability characteristic gene rally w ill be conced ed. But, some LLC
statutes do allow the constituent documents to create liability.
(4) Continuity of Life.
As described in Section F., above, care must be taken to draft the regulations or operating
agreement to avoid the continuity of life characteristic (that is, to assure that an LLC does not have continuity of
life), if that is one of the two characteristics that the LLC must avoid to preserve its federal pass-through tax
treatm ent.
(6) Free Transferab ility of Inte rests.
The Treasury Regulations look at two components of an ownership interest in testing
for free transferability: (i) econ omic rights, which typically are the right to receive profits and distributions, and
(ii) voting and other management rights. If only the economic rights are freely transferable (which is the case
under modern partnership statutes and under LLC statutes, absent a contractual agreement to the contrary), then
free transferability w ill be avoided . On th e othe r hand, if, for ex ample, the regulations of an L LC a llowed a
member to transfer the m ember's interest to a third pa rty and , witho ut con sent, to make the transferee a substituted
mem ber, then the element of free transferability would be present. Again, this does not, by itself, elim inate
pass-through tax treatment; but, it does lock-in one of the four corporate characteristics -- the refore, great care
would have to be taken to avoid centralized management and continuity of life if, as anticipated, limited liability
is conceded.
The rules applicable to limited partnerships and LLCs are the same and should be applied in the same
manner. However, public pronouncements hav e distorted the manner in which these rules apply to limited
partnerships and only private rulings have defin ed the man ner in which these rules apply to LLC's. See, e.g., PLR
9210019 (Texas law -- no free tran sferab ility wh ere full substitution of non-manager members requires only the
consent of the sole manager, and transfer of the manager's interest requires consent of a majority in interest of the
members.). A detailed discussion is set forth in Article III., abov e, "TA X C LASSIF ICA TIO N."
(8) Centralized Management.
As noted above, some LLC statutes allow an LLC to be managed either by managers or
mem bers, as pro vided in the A rticles. However, the current IRS position appears to be that unless management
is reserved to the mem bers, the LL C w ill have centra lized m anag ement. For example, in Revenue Ruling 93-6,

SAW - 39
the IRS held that a Colorado LLC with five members, all of whom were also managers, had centralization of
management because m anag ement of th e LLC w as vested in man agers rather th an m embers. Rev. Rul. 93-6, 1993
- 3 I.R.B. 9, 10. The IRS's rationale was based on the fact that the decision-making authority rested in the
mem bers' capacity as elected manage rs, rather than in their capacity as members. T his do es not com port w ith
Treasury Regulations § 301.7701-2(c)(1), which states that "an organization has centralized management if any
person (or any group of persons which does not include all the mem bers) had contin uing exclu sive au thority to
make the management decisions necessary to the conduct of the business for which th e organization w as form ed."
Because the treatment of LLC's conflicts with the treatment of limited partnerships and the T reasury Regulations
themselves, this ano maly sho uld be elim inated in the fu ture. For now, the only com pletely safe w ay to a void
centralization of managem ent in the LLC context is to reserve managem ent to all of the members, as members.
Some of the practical problems of reserving management to all of the members may be avoidable by having
the members to whom that management has been reserved name one or more, but fewer than all, of their number
to cond uct actual da y-to-d ay m anag ement. This would be comparable to multiple general partners naming a
managing general partner, or to the shareholders of a close corporation delegating managem ent to one shareholder.
At this time it can only be suggested (but not guaranteed) that such a solution would be respected by the IRS and
result in a findin g of no cen tralization of m anag ement.
(10) Franchise Taxes.
State legislatures everyw here are furiously looking for ways to increase state revenues.
In som e states (e.g., Flo rida, N ew Y ork's p ropo sed sta tute an d Texas), this has re sulted in the imp osition of a
franchise or corporate income tax applic able to corporation s and to LLC's (but not to partnerships). For example,
in Texas, 1991 am endm ents to the Texas franchise tax laws impose on corporations doing business in Texas a tax
equal to the greater of (i) 0.25% of "net taxab le capital" (which is similar to the old computation, but reduced from
0.525% to 0.25%) and (ii) 4.5% of federal taxable income, with certain adjustments. Texas Tax Code
§ 1.71.001(a)(2). By any name, this is a corporate incom e tax, wh ich is a serious draw back to ope rating in
corporate form. The Texas legislature made this tax applicable to LLC's, presumably because they are
"corp oration -like."
In limited circumstances, the federal income tax benefit of effectively converting recourse indeb tedne ss to
nonrecourse by using an LLC -- because no owner has perso nal liability, all debts are effectively nonrecourse and
the additional tax basis that is created is shared b y the members as they agree -- may outweigh the adverse
consequences of the state franchise tax.
6. S Corporations.
b. Federal Income Taxes.
The only reason to elect S Corp status is the tax advantage of the pass-through partnership tax
treatm ent; otherwise, the o peration for state law purposes is the same as with a C C orporation. The cost of S Corp
status is the requirement to suffer shareholder and other restriction s that do not ap ply to a C Corpo ration o r to
partnerships or LLC 's. If S Corp status is properly elected, and if the rules that must be satisfied for that statu s to
be maintained are observed, flow-through aspect of the basic fede ral incom e tax treatmen t is the same as for a
partnership. There are, however, very important distinctions. For exam ple, a shareholder in an S Corp may not
increase its tax basis by any p ortion of the c orpo ration's debt o r by person ally gu arante eing c orpo rate de bt. This
difference makes ownership throu gh a lim ited liability company or partnership more desirable than through an
S Corp.

SAW - 40
d. Franchise Taxes.
S Corporations are subject to the same franchise tax liability as C Corporations and LLC's, as
discussed at subparagraph (5), above.

SAW - 41
P. METHODS FOR GETTING VALUE OUT.
The key issue fo r many owners -- w hen a nd how do I get valu e out:
SUMMARY
L P'ship
Distribution of property not a taxable even t. Recipient partner has
carryover holding period and takes a basis equal to lesser of partn ership's
tax basis in the p roperty or partner's tax basis in its pa rtnership interest.
Cash distributions don't result in entity taxation; distributee partner taxed
only to extent tax exceeds distribu tee's tax basis in partnership interest.
LLC
S Corp
Generally, treated the same as L P'ship.
Distribution of property is a taxable event. Ca n result in corporate level
tax if property "tainted" because of a C Corporation history.
Shareholder has new holding period and takes tax basis equal to
property's fair market value.
Cash distribution generally treated the same as for L P'ship, unless S Co rp
has retained earnings from prior period as a C Corporation.
Winner:
If gains are planned for, advanta ge to L P'ship or LLC because no
taxable event on property distribution. But, if property has declined
in value, S Corp has advantage of being able to generate tax loss by a
distribution (without a disposition outside the ownership group).
2. General Rule - Partnerships.
The partne rship fo rm o f ownersh ip allow s considerable flex ibility, and gen erally favorable tax
treatm ent, in getting assets into and out of the partnership, and in allocating and distributing income and cash
among the partners. Generally, there is more flexibility during the operational phase of the partnership than on
liquidation -- at the end of the day, the scorecard (in the form of the partners' capital accounts) must be totaled,
and final distributions made accordingly. Tax basis, capital account balances and allocations made during the
partnership term all have direct bearings on h ow the assets com e out to the partners.
4. Com parison Su mm ary.
A com parativ e sum mary of this issue m ay be more useful than separating the discussion b y entity
type. The major difference between L P'ships and L LC's, on the one h and, a nd S Corp s, on the othe r, relates to
the distribution of property other than cash. Any entity taxed as a partnership (i.e. general partnerships and most
limited partnerships and LLC's) does not treat a distribution of property as a taxable event; however, an S Corp
does. Although the S Corp generally is not required to pay any tax itself when it distributes property (unless the
property is "tainted" because the property has a C corporation history ), the S Corp is required to re cogn ize gain
or loss on the distribution of pro perty as if it we re sold for its fair m arket v alue. A s a resu lt, each of its
shareholders must recognize an allocable share of the c orpo ration's gain o r loss. Becau se of this difference in

SAW - 42
taxation, the tax basis and holding period of distributed property in a distributee's hands also is different. A partner
has a carry over holding period and ta kes a basis in the property equal to the lesser of the pa rtnersh ip's tax b asis
in that pro perty and th e partn er's tax b asis in its p artners hip inte rest. An S Corp shareholder has a new holding
period and takes a tax basis in the property equal to the property's fair market value.
Otherwise, the entities generally are treated similarly. Cash distributions do not result in any entity taxation,
and the distributee has a tax o nly to th e extent the cash distribution exc eeds the distributee 's tax ba sis in his
ownersh ip interest. T he ex ceptio n to this rule is if an S Corp has some retained earnings from a period that it or
a predecessor was a C corporation.
6. Gains v. Losses
Assuming you plan for gains rather than losses, the advantage goes to partnerships or LLCs becau se
they do not hav e a taxable event o n a pro perty distribu tion. H owever, if p roperty has declined in value, then
S Corp has an advantage, as it can generate a tax loss for its owners by simply distributing that property, without
a further disposition or liquidation.
8. Shifting Taxable Items.
Another consideration in this area relates to shifting taxable items. There are extensive rules that
prevent the use of a partnership to shift taxable gain or loss on appreciated or depreciated property, respectively,
from a con tributing partne r to othe rs. No similar rules apply to S Corp s, which can present a p lannin g opportunity
in the right circumstances.
X. SUMMARY OF THE VARIOUS CONSIDERATIONS.
B. GENERAL OVERVIEW.
C and S Corporations provide owners with protection from liabilities arising out of the operation of a
business. Unless there is an overriding reason to use a C Corp oration , how ever, a real esta te inve stment sho uld
generally be made by means of a tax pass-through entity like an S Corp, a partnership, or an LLC.
Although there are many circumstances in which using a gene ral partn ership or a joint venture is
appropriate, if the owners want to limit their liability (as is usual), the general partne rship is n ot preferred. LLC's
provide protection against liability, but the local tax treatment of them may be un favorable. Limited partnerships
provide limited liability to lim ited pa rtners, b ut not to the genera l partne rs (altho ugh this limitation may be
effectively avoided by creating a corporation to be the general partner of the limited pa rtnership).
Consequently, in most situations, real estate activities g enera lly should be organized in limited partnership,
S Co rp or L LC form to get th e ben efit of bo th pass-throu gh tax treatm ent an d som e limited liability.
D. ENTITY BY ENTITY COMPARISON.
2. One Ow ner - P roprietorship , S Co rp, LL C or L imited Partnership .
Where there is only one owner, the person's desire to limit liability as an owner must first be
determined. If liability avoidance is desired, then the S Corp is perhaps the easiest option. But, an S Corp may
be subject to a local tax (e.g., franchise tax). For that reason, the best solution may be partnership form, used by
forming a corporation or subsidiary to be the general partner in a lim ited pa rtnersh ip. Tw o neg ative aspects of this

SAW - 43
tiered structure are (i) the added expense of form ing an d maintaining (e.g ., tax returns, co rporate formalities) the
additional entity, and (ii) a risk that the IRS may attempt to treat the partnership as a corporation for tax purposes
by finding three or more of the four corporate characteristics. Also, it is more difficult, although not impossible,
to ensure partnership tax treatm ent if there is a sole corpo rate general partner.
Note that the TLLCA and the current draft of the ULLCA allow a one-member LLC. There has been no
determination by the Service that a one-member LL C w ill be treated as a partnership for federal income tax
purposes. In fact, it is this feature of the TLLCA which, to date, has precluded the issuance of a ruling by the IRS
that a Texas LLC will be so treated for federal income tax purposes. Consequently, Texas practitioners are not
taking advantage of the one-owner feature of the TLLCA.
4. Multiple Owners -- Numerous Options.
As noted above, the basic cho ices of entity wh en there are m ultiple owners are gene ral partn ership
(joint venture), limited partnership, C Corporation, S Corp, and LLC. Although the general partnership/joint
venture option remains viable, especially where all of the investors will be required by lenders or other third parties
to have liability for the debts of the enterprise, because the desire for limited liability is one of the ke y goals in
choosing the form of business entity today, general partnerships and joint ventures will not be discussed in this
comparison.
Likewise, although a C Corporation may be the be st choice in so me circum stances, bec ause that will rarely
be the case in a real estate transaction, C Corporations are not discussed in this comparison. Both C Corporations
and general partnerships/joint ventures are, however, included in the "Com parison of S tructures" chart attached
to this paper.
b. S Co rp v. L P'ship.
The decisio n betw een th ese tw o entities often turns p rimarily on balancing th e com plete
absence of personal liability for S Corp own ers with the fre edom and fle xibility o ffered by the partne rship; b ut,
the follo wing factors can also be releva nt:
(2) Formation Costs - Generally, it is less expens ive to pre pare c onstituent do cum ents
for an S Corp than for an L P'ship; filing expenses vary by state.
(4) Participation in Management - There are no restrictions on participation by
shareholders of a S Corp in the management of the corporation, as officers, directors or employees; while broad
rights can b e gran ted to limited partners, there are still restrictions and risks (of loss of limited liability) associated
with full participation in managem ent by limited partners.
(6) Tran sferab ility - Subject to contrary agree ments am ong the ow ners, the econom ic
rights associated with either type of ownership interest are freely transferable. However, subject to the use of buysell
or other shareholders' agreements to preclude transfers to non-qualifying shareholders (which is very
important), the en tire ow nersh ip intere st of an S Co rp sha reholder is usually more read ily transferable than the right
to become a substituted limited partner in an L P'ship.
(8) Type of Owner - There are n o restrictions on wh o can own an L P'ship interest,
but there are severe restrictions on who can be a shareholder in an S Corp (ownersh ip is limited to U .S. resid ents
and citizens and certain U.S. trusts). If there are foreign owners or non-individual owners, an S Corp is not
available.

SAW - 44
(10) Number of Ow ners - There is no limit on the number of L P'ship owners (subject
to potential securities laws issues), whereas there can be no more than 35 shareholders of an S Corp.
(12) Federal Tax Issues - The pen dulum begins to sw ing toward the L P'ship form w hen
federal income tax considerations are introduced. Although both entities are pass-through entities that avoid tax
at the entity level, the tax ba sis of an S Corp shareholder includes only the amount of money the shareholder has
contributed or lent to the c orp oration, and doe s no t include the s hareho lder's pro rata share of the corpor ation's
nonrecourse debt. On the other hand, a limited partner has a tax basis eq ual to th e valu e of its inv estment in its
L P'ship interest, plus its percentag e share of partners hip nonrecourse debt, plus (this would be som ewhat less
usual) any partnership debt for which it is personally liable (for exa mple, as a g uarantor).
- The allocation of tax items of an S Corp are made to the shareholders prorata
based on their stock ownership (or through complex compensation or debt structures); on the other hand, there is
freedom to m ake special allocations in the L P'ship context that differ from ow nership percentages.
(14) State Taxes - The scale tips even further in favor of the L P'ship in states wh ere
a franchise tax applies to a corporation but not a partnership.
Conclusion: Although the S Corp has attractive features and some advantages, the L P'ship genera lly
would be the entity of choice, and especially wh ere a state franchise or sim ilar tax applies to corp orate
entities but not to partnerships.
d. S Corp v. LLC.
the key factors:
When the merits of an S Corp are being considered against those o f an LLC , the following are
(2) Tran sferab ility - Under applicable statutory law, an ownership interest in either
an S Corp or an LLC may be freely and fully transferred to a third party. However, in the LLC context, under
current IRS private rulings, if more than economic rights are transferred w ithout consent of the manager or a
majority-in-interest of the other members, the corporate chara cteristic of free tran sferab ility would be present. For
an S Corp, transfers to an unqualified shareholder, which would jeopardize S Corp (and partnership taxation)
status, are troublesome, but like ly wo uld be prev ented by ag reem ent.
(4) Type of Owner - The same advantages described with respect to an L P'ship,
above, wou ld app ly in the case o f an LLC h ere: an LLC offers m uch m ore freedom to hav e foreig ners and en tity
mem bers.
shareholders.
(6) Number of Ow ners - No upper limit with LLC's, but there can be only 35 S Corp
(8) Federal Tax Issues - The same adva ntage s of op erating in L P'ship form w ould
apply to LLC's here, with the potential additional advantage that LLC recourse debt is shared by the members as
nonreco urse debt (because no mem ber has personal liability).
(10) State Taxes - Both forms of entity are tagged here, but there are some open issues
with regard to the income of an LLC.

SAW - 45
Conclusion: Except where extraterritorial activity is contemplated (especially in a state with no LLC
statute), the LLC form, with its greater flexibility for federal income tax purposes and types of owners,
will generally be preferred to an S Corp.
f. LLC v. L P 'ship.
are as follows:
The primary factors that should be considered in the d ecision betw een th ese tw o types of entity
(2) Participation in Management - The mem bers o f an LLC a re more free to fully
particip ate in management, either as mem bers or as managers, than are the limited partners of an L P'ship, without
fear of losing limited liability.
(4) Tran sferab ility - Although most states' LLC and L P'ship statute treat the issue of
transfe rability of interests similarly, there is currently more risk from a tax classification standpoint regarding
LLC's than for L P'ships, as is more fully discussed above.
(6) Limited Liability - All mem bers of an LLC have limited liability, where there must
be at least one general partner of an L P'ship who has full liability. While an adequately capitalized corporation
or other e ntity (su ch as an LLC!) can b e used as the gen eral pa rtner to g ive lim ited liability to all ow ners, that
option is generally more expensive than using an LLC and may not necessarily result in the partnership's lacking
limited liability for tax purposes.
(8) Federal Tax Issues - As noted above, third party indebtedness which is recourse
debt to an LLC is shared in the tax basis of all members in the way that nonrecourse debt is shared by the partners
of an L P'sh ip; on th e othe r hand, absent lim ited pa rtner guaran tees, on ly the general partner of an L P'ship may
take advan tage o f partnership recou rse debt.
(10) State Taxes - As discussed in the comparison between an S Corp and a n L P 'ship
in Subparagraph a., above, those states that impose a franchise or corporate income tax on corporations and LLCs
provide an additional major advantage to partnerships.
Conclusion: Where franchise or other loc al tax issues are presen t, L P'ships generally will be preferred
to LLC's for real estate investm ents.* Ad ditionally, the uncertain extraterritoria l treatment of LLC 's
is another current (but, perhaps, diminishing) disadvantage to their use for enterprises that expect much
activity outside the state of formation.
F. COMPARISON OF STRUCTURES CHART.
Attached to this paper is a chart comparing the various structures' treatment of the key factors that bear on
the choice of entity.

SAW - 46
XII.
CONCLUSION.
Cho osing the "rig ht" entity for a real estate transaction is not always a simple matter. Many issues, some
complex, often must be carefully analyzed. Revenue rulings and other Internal Revenue Service pronouncem ents
must be monitored. Nevertheless, in the current environment, the choices most often are reduced to limited
partnerships and LLC's, which, if carefully structured, offer the attractive combination of (i) limited owner liability,
(ii) partnership federal income tax treatment and (iii) considerable flexibility. Unfortunately, some jurisdictions
impose a franchise or similar tax on LLC's, rendering them unusable.*
* Subsequent to the preparation of this paper, it was learned that the proposed New
York LLC legislation has been modified to delete the provision for a franchise tax for
LLC's, and to add a provision enabling the form ation of professional LLP's.
Attachments
Appendix A
LLC & LLP State Legislation
Appendix B IRS Reven ue R ulings / P rivate Le tter R ulings (C lassification Issu es) F or L LC 's
Appendix C Com parison O f Structures Chart
s-0006145.04