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Owning Real Estate: The Limited Liability Company
By Dan DiTieri, CPA
Since their first appearance 13 years ago, limited liability companies (LLCs) have become a popular form of real estate ownership in all 50 states. (While state statutes are based on the Uniform Limited Liability Company Act, they may differ in some particulars.) An LLC is an unincorporated form of business that typically provides for limited liability of its managers and owners (called members) and for flow-through tax treatment. An LLC is similar in some ways to a general partnership and in other ways to a limited partnership.
Like a corporation, an LLC is considered a foreign business entity in every state other than its state of formation and so must register to do business outside its home state. Additionally, analogous to a corporation, an LLC is considered a separate legal entity that can enter into contracts, hold title to property, and sue (and be sued) in its own name. However, LLCs are unlike corporations in some important ways. For example, ownership interests are not freely transferable. Moreover, the duration of the business is not perpetual; the LLC, like a general partnership, is subject to dissolution upon the occurrence of certain events.
LLC and S Corporations
LLCs are free of certain restrictions that limit the usefulness of S corporations. For example, no limit is imposed on the number of LLC members and the LLC can create different classes of memberships, including preferred and subordinated interests in capital, profits and cash flow. By comparison, an S corporation is limited to one class of stock and can have a limited number of shareholders. Finally, only individuals or certain trusts may be S corporation shareholders, whereas shares in an LLC may be held by other LLCs or by corporations. This permits LLC members to further limit their liability to an amount less than the investment in the primary LLC.
Flow-Through Tax Treatment
One of the most important attributes of an LLC is flow-through tax treatment. Like partnerships and S corporations, LLCs are not subject to federal income tax at the entity level; instead, all items of income, loss, deductions, and the like flow through to and are reported by the owners.
Centralized Management
An LLC is a separate legal entity that acts through its authorized agents. The owners of an LLC are called members. Most statutes provide that an LLC can be member-managed or managed by non-owner professional managers. An LLC will be considered to have centralized management whenever a group consisting of fewer than all the members has continuing exclusive authority to make management decisions.
Lender Concerns
It is important for lenders to ensure that members of an LLC borrower have dealt appropriately with issues relating to disassociation of a member (and the purchase of his or her interest) or dissolution of the LLC itself. This is the same concern lenders have with general partnerships.
The lender needs assurance that if the LLC is required to purchase a disassociating member's interest in the business, this will not cause financial disruption to the company. The Operating Agreement (the governing document for an LLC), should provide a valuation formula so that costly litigation concerning can be avoided. In addition, payments by the LLC should be structured over a period of time so that raising the necessary cash does not require liquidation of business assets.
Dan DiTieri is a Senior Manager in the Real Estate Practice Group in BDO Seidman's New York office. He can be reached at (212) 885-8378.
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