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Corporation or Partnership?

By Karen E. Klein Q: My family and I are beginning a real estate investment business that I will be managing, but I'm not sure what legal structure to establish for it. I spoke with a mortgage lender and he warned me that corporations tend to be charged higher loan rates. He also revealed that he and his partner use a legal partnership for their investment business. Does the money one starts with impact the type of structure one should use? Collectively, we have about $20,000, with each member contributing around $2,000. Would we be better off with a corporation or a partnership? -- T.S., Baltimore

A: There are a couple of legal issues posed by your question, which is a deceptively complex. In order to be absolutely sure that you are starting your business on the right foundation -- and you owe it to yourself and your family to do no less -- get personal advice from your tax adviser, who will typically be a lawyer or accountant who specializes in small-business matters.

However, Marco D. Costales, a lawyer with the law firm of Nossaman, Guthner, Knox & Elliott in Los Angeles, recommends that you investigate establishing a limited liability company, commonly called an "LLC."

TAXES AND LAWSUITS. "As a legal matter, lenders should not be charging corporate borrowers higher interest than borrowers using another form of legal entity, such as a partnership or limited liability company," Costales says. "But as a practical matter, if you find that this is occurring, you should consider setting up a limited liability company, which enjoys the liability protection of a corporation and the 'flow-through' tax treatment of a partnership. These entities tend to offer the best of both worlds."

The amount of money that one starts with does not impact the analysis of which type of legal entity to use, Costales says. But there are serious tax and liability implications that hinge on setting up the proper legal structure for your business. Once you have done that, it's neither easy nor cheap to make a change if you find you've blundered early on.

Also, "keep in mind that no matter what type of entity you choose, it must be adequately capitalized so that the owners may enjoy liability protection," Costales warns. Good luck.

Have a question about your business? Ask our small-business experts. Send us an e-mail at Smart Answers, or write to Smart Answers, BW Online, 45th Floor, 1221 Avenue of the Americas, New York, N.Y. 10020. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally. Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.

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