Converting Partnerships to Limited Liability Companies

Limited Liability Companies ("LLC"), rather than limited partnerships, have become the planning tool of choice for owners of real estate seeking to protect themselves from liability. What if you have an existing partnership and you want to convert to an LLC? The discussion below applies to all partnerships, general or limited.

As background, generally a member of an LLC is not personally liable for damages arising from activity inside the LLC. On the other hand, a general partner of a limited partnership is personally liable for damages arising from activity inside the partnership. Take this example:

Smith’s limited partnership owns an apartment building. Smith serves as the general partner. The apartment furnace blows up, killing and injuring a number of tenants. After several trials, a judgment is entered for negligence which far exceeds Smith’s property insurance. (By the way, Smith should also have an umbrella insurance policy.) Not only can creditors reach the partnership assets, Smith’s personal assets are also subject to the judgment. In contrast, if Smith had conveyed the apartment to an LLC rather than a partnership, although the LLC assets would be lost, Smith’s own assets would have been protected. (Smith could also have avoided personal liability by forming a Corporation and having the Corporation act as the general partner, but this adds to the complexity and cost of the transaction.)

The solution is to convert the limited partnership to an LLC. Now, the LLC members’ assets are protected, and the former general partners do not need to worry about personal liability.

Most states have made it relatively easy to convert an existing limited partnership to an LLC. The LLC agreement can provide the same management provisions, restrictions on transfer, and other pertinent terms that existed under the partnership agreement. Assuming the LLC members have the same pro rata interests that they owned as partners, there should be no tax consequences. Notwithstanding, you should consult with your tax attorney or accountant upon conversion. For example, debt forgiveness may trigger tax consequences to general partners.

In sum, for general and limited partnerships holding assets that can cause liability concerns, conversion to an LLC should be considered and probably implemented.