Important opportunity for real estate entities.

• Author: Morisky, Dick

Business transactions involving real estate typically focus on the fundamental issue of the proper choice of entity. To take advantage of a recent IRS notice, partnership agreements should give general partners the authority to make any election available regarding the classification of the entity.

Most taxpayers have used limited partnerships or limited liability companies (LLCs) as entities for real estate transactions. These entities are typically favored because they allow for passthrough treatment for income tax purposes, thus minimizing the double tax inherent in C corporations. S corporations have generally been less popular. Although they provide passthrough income tax treatment for shareholders, they are more complex and restrictive than partnerships or LLCs.

Under existing statutes, certain technical rules must be followed for an entity to receive partnership status. An incorporated organization will fail the partnership test if it has a preponderance of four corporate characteristics: (1) continuity of life, (2) centralized management, (3) limited liability and (4) free transferability of interests.

Limited partnerships, and more recently LLCs, have been able to satisfy these requirements by lacking continuity of life and free transferability of interests. In other words, with proper tax planning, partnership status can be reasonably obtained through the current rules.

The Service has recently announced in Notice 95-14 that it is considering simplification of the regulations to allow unincorporated business organizations to elect status as a partnership or as a taxable corporation.

Existing regulations setting out classification guidelines have been based on traditional differences under state law between partnerships and corporations. Several states have recently amended their laws, resulting in partnerships and other unincorporated organizations possessing some of the same characteristics. For example, many partnership statutes have been revised to provide that no partner is unconditionally liable for all of the partnership's debts.

In addition, most states have enacted laws concerning the formation of LLCs, which provide limited liability to their members in a manner similar to corporations, but can also qualify as...