With increasing aggressive state taxation and heightened compliance, a proactive approach to evaluating domicile and nexus is imperative.
Real estate partnerships often face complex questions about where to register and which states can tax their activities, especially when investment teams operate in one state but acquire properties in others. California is a common focal point due to its large investor base, expansive tax rules, and broad nexus interpretation.
With increasingly aggressive state taxation and heightened compliance, a proactive approach to evaluating domicile and nexus is imperative. Each partnership must be assessed based on its formation state, property locations, investor residency, and management activities. Understanding these nuances is key to avoiding costly missteps and complying across jurisdictions.
A common scenario: California-based manager, out-of-state assets
Consider a real estate asset manager headquartered in California who forms a partnership to acquire properties exclusively in other states, such as Arizona, Nevada, and Texas. Despite the out-of-state assets, assume that the partnership’s investors reside in California. This raises a key question: Does the partnership need to register as a foreign entity in California and file California tax returns? It depends.
Domicile vs. foreign registration: What’s the difference?
A partnership is legally domiciled in the state where it is formed. For instance, if formed in Delaware, a popular choice, Delaware is its state of legal domicile.
However, once an entity conducts operations in another state, it may be required to register there as a “foreign” entity with that state’s tax authority (and perhaps with that state’s secretary of state). For taxation purposes, the definition of “doing business” varies significantly by state, which is where much of the complexity lies.
- California’s broad threshold — For income tax purposes, California’s broad definition of “doing business” includes having California property, payroll, or sales exceeding certain thresholds. Some states may require partnership tax return filings from partnerships with in-state-based investors receiving pass-through income, even if the partnership holds no assets in the state.
- Other states’ narrower focus — Many states concentrate solely on physical presence. For example, a state may require registration only if the partnership has property, employees, or a business footprint within the state. Delaware, while often chosen for formation, imposes an annual franchise tax but typically does not require tax return filings unless the entity operates there.
Where you form a real estate partnership isn’t always where you file
When structuring a real estate partnership with multistate assets and investors, it’s essential to understand the difference between where an entity is formed and where it must register or file. States like Delaware and Nevada are often chosen as states to form an entity due to their legal flexibility, but partnerships should expect to register in any state where they directly own property.
Additionally, investor residency can trigger filing obligations. California, for instance, has a broad definition of “doing business” and may require filings from partnerships with California-based managers or investors, even if no assets are in the state.
Legal registration and tax filings don’t always overlap — registration is a legal requirement with the secretary of state, depending on instate “transactional presence,” while registration with a state tax authority and filing applicable tax returns are driven by a state’s “nexus standards.” These distinctions — between domicile, legal registrations, and taxation nexus — must be evaluated independently.
Not properly registering and complying could potentially subject a partnership and its investors to significant tax, fees, interest and penalties. Early consultation with legal and tax advisors can help align the partnership’s structure with its investor base and property footprint, reducing compliance risk and avoiding surprises.
How CLA can help with nexus and state registration considerations
Multistate registration and tax compliance can be complex, but CLA can help simplify it. Our real estate professionals work with asset managers, fund sponsors, and operators to assess filing obligations, shape entity selection, and liaise with legal counsel and state agencies. We also support ongoing tax filings and provide lifecycle guidance, from formation to disposition, so you can focus on growing your portfolio with confidence.