258 Planning and Forecasting
decide to form an entity to construct and own the hotel building, separate from
the entity that manages the ongoing hotel business.
This plan would convert a rather confusing real estate/operating venture
into a pure real estate investment opportunity for potential investors. The real
estate entity would receive enough revenue from the management entity to
cover its cash f low and would generate tax losses through depreciation, interest,
and real estate taxes. These short-term losses would eventually yield long-term
capital gains when the hotel is sold, so this entity would attract investors look-
ing for short-term losses and long-term capital appreciation. For the short-term
losses to be attractive, however, they must be usable by the investors on their
personal returns and not trapped at the business entity level.
All these factors point inevitably to the use of either the limited partner-
ship, LLC, or subchapter S corporation for the hotel building entity. All three
entities allow the tax losses to pass through to the owners for use on their per-
sonal returns. Among these three choices, the limited partnership and LLC
allow more f lexibility in allocating losses to the investors, and away from
Bruce, Erika, and Michael (who most likely do not need them), and they pro-
vide higher limits on the amounts of losses each investor may use.
In past years, our entrepreneurs would thus face the unenviable choice
between losing the tax advantages of the limited partnership to preserve the
limited liability offered by the subchapter S corporation or preserving the tax
advantages (and the ability to attract investors) by either accepting personal li-
ability as general partners or attempting to adequately capitalize a corporate
general partner. This choice is no longer necessary with the advent of the LLC,
which solves the problem by offering the tax advantages of the limited partner-
ship and the liability protection of the subchapter S corporation. However, the
passive loss limitations will still impact upon the usefulness of the losses for the
members who do not have significant passive income, making this project (as
is the case with most real estate investments in today’s climate) more difficult
to sell.
This leaves the entity which will operate the hotel business itself. The
presence of our three principals immediately eliminates the sole proprietorship
as a possibility. Because all the investment capital has already been raised for
the real estate entity, there does not seem to be a need for further investors,
thus eliminating the limited partnership as a possibility. The partnership seems
inapplicable, since it is unlikely that any of the principals would wish to expose
himself or herself to unlimited liability in such a consumer-oriented business.
Thus, the corporation and LLC with their limited liability, continuity,
and transferability, seem to be the obvious choices for this potentially growing
and successful business. As with Phil, it becomes necessary to decide whether
to make the subchapter S election or choose an LLC to achieve tax pass-
through. This decision will be made on the basis of the parties’ projections.
Are there likely to be serious losses in the short-term, which might be usable on
their personal tax returns? Will there be a need for significant capital expendi-
tures, thus indicating a need for the low-end corporate tax rates? Will the