Real Estate Managers Sing Praises of New Financial Hybrid
Owners of commercial and multifamily real estate are all talking about LLCs--limited liability companies.
The LLC is a hybrid of sorts, combining the limited liability of a corporation with the simplicity and tax benefits of a limited partnership.
Real estate owners and managers are becoming particularly enamored with this new hybrid, and are transferring many of their assets into LLCs. Creating LLCs has also become a widespread cottage industry for lawyers, accountants and real estate consultants, who are aggressively marketing LLCs as a way to generate new business.
“LLCs combine several of the most important benefits of corporations and limited partnerships,” according to Samuel H. Gruenbaum, a partner at the Century City-based law firm of Cox, Castle & Nicholson. He said they could be “extremely useful in real estate ventures in the years ahead.”
LLCs became legal in California last fall. Most of the other 49 states have passed similar laws authorizing LLCs and lobbyists for the real estate industry in Sacramento were clamoring for California to follow suit.
“LLCs are the vehicle of the ‘90s for owning and operating real estate,” said Steven M. Friedman, a partner with E&Y;/Kenneth Leventhal Group in Century City and a resident of Sherman Oaks.
It’s too early for statistics, but the indications are that many new LLCs are being formed in California--many of them in the San Fernando Valley and Ventura County.
Until the creation of the LLC, groups of people investing in real estate together generally had to choose between creating some form of a corporation or a partnership. Each of these entities, however, had a downside for many real estate investors:
* So-called C corporations are taxed both at the corporate level and again when shareholders realize a gain on their investment.
* S corporations avoid double taxation, but S corporations are limited to 35 shareholders, exclude foreign investors and don’t provide the tax benefits of a stepped-up basis for assets passed on to shareholders’ heirs.
* Partnerships don’t suffer from double taxation, but they don’t offer the limited liability of corporations. If someone sues a corporation, the shareholders aren’t individually liable. If someone sues a limited partnership, however, the general partner may be personally liable for certain types of damages. If it’s a general partnership, all the partners are exposed.
The LLC is becoming popular because it isn’t taxed twice like a C corporation, there aren’t limits on shareholders as in an S corporation and the investors don’t have personal liability for actions as in partnerships.
One group recently represented by Friedman in forming an LLC is a small group of private investors involved in buying distressed commercial and multifamily apartment buildings in the San Fernando Valley and then either fixing the properties up or putting them into better financial shape. If LLCs didn’t exist, the investors probably would be buying their properties as limited partnerships.
There are all sorts of investors who might have liked to take advantage of the single-level taxation of S corporations but for various reasons couldn’t--making the LLC the most favorable form of ownership available to them, said Andrew S. Kane, managing partner at Arthur Andersen LLP, which has San Fernando Valley offices in Warner Center. (LLPs--in case you are wondering--are limited liability partnerships that seem to be favored by professional service groups such as accountants.)
One recent LLC, Kane said, involved a family with a variety of real estate holding in the San Fernando Valley. Because part of the family lives in Europe, an S corporation wasn’t an acceptable way for them to own and operate their real estate since it doesn’t permit foreign shareholders. Another example of an LLC involved apartments and retail properties owned by a family with many members living in the Valley. The family wanted two classes of stock with different voting rights--but that’s also not allowed in an S corporation.
“All these tax and ownership issues are important for people who own and operate real estate,” Kane said. “The LLC is now the best way to avoid personal liability and at the same time avoid being taxed twice.”
LLCs aren’t just for people or entities that own lots of real estate. An LLC is one way that certain high net-worth families are passing real estate on to their children and grandchildren. It’s another alternative to passing on the property through a will or a living trust.
In order to qualify as an LLC, a company must meet very specific U.S. Treasury regulations in order to avoid the double taxation of C corporations. LLCs also cost between $2,000 and $3,000 in professional law and accounting fees. Finally, LLC must be scrupulously prepared. “You want to make sure your t’s are all crossed and all your i’s are dotted,” Kane said.
