When setting up a real estate investment, there are a number of decisions involved, both small and extremely consequential. One of the latter is determining how much risk and responsibility you’re willing to take on, should you be unable to repay your debts, and for paying any taxes. Unlimited liability, while likely the simplest arrangement, can also be the riskiest, depending on how much capital you have on the line.
What Is Unlimited Liability?
For business owners, unlimited liability means taking the full legal responsibility for all business debts. This liability is uncapped, and debts can be met through the seizure of any and all of the owners’ personal assets. They are also solely responsible for taxes. This rule applies to sole proprietors and multiple parties that have entered into a partnership. In a sole proprietorship, one person is entirely responsible, and in a general partnership, the debt is split between partners.
Risks and Benefit of Unlimited Liability
There are two main benefits of unlimited liability. One is its simplicity. As Chron wrote, unlike arrangements that offer more protection, it doesn’t require a lot of upfront paperwork, and is inexpensive to start. In some places, including Ireland, nondisclosure is also a benefit at least for some types of companies, though a 2017 law restricted the types of companies that can use it. For those companies that can, this means they aren’t responsible for public reports on their money or tax payments.
Aside from these two benefits, unlimited liability more often comes with risks. as we’ll explore in the example below.
An Example of Unlimited Liability in Commercial Real Estate
Let’s say two partners have each invested $50,000 into renovations for their shared multifamily building. Along the way costs balloon, maybe someone got carried away with marble staircases, and suddenly the $100,000 project is now a $250,000. If neither of the partners can repay the debts, and they have unlimited liability, each of them are equally responsible for making up the difference.
In addition to the initial $50,000 they each paid, they each have to pay an additional $50,000 to make up the debt. If they don’t have cash, their personal assets may be seized. If it’s just one person who invested in the building, that one person is responsible for all the debts and may have their assets seized to repay them.
Unlimited Liability vs Limited Liability
There are a number of business entities that offer more protection than unlimited liability arrangements. These include limited liability partnerships, regular corporations, S corporations and limited liability companies, which all offer varying levels of liability and protection against personal asset seizure and debt. Many investors prefer to form a limited partnership, where a partner’s liability will not exceed their investment in the company.
A single investor or a group of partners may also decide to form an LLC, or Limited Liability Corporation, as the vehicle for investment and taxation. leverage.com previously wrote that an LLC differs from a general or sole proprietorship with unlimited liability, “because of its personal liability limitations, and the option of pass-through taxation to the individual members.” In addition, “while the default taxation mode of an LLC is to be taxed as a partnership, members can also flexibly elect to be taxed as an individual sole proprietor, or C or S corporation.”
The Easiest Option is Not Always The Best
While they seem simple, unlimited liability arrangements can be financially painful in the long-term. Unless you are very confident about your ability to repay debt (and have extensive funds lying around), you may want to consider arranging a limited partnership, or forming an LLC. It will make tackling debt more manageable, and protect your personal assets. You may also consider obtaining liability insurance as another form of protection.