Corporation or LLC

[Davit Gharibyan]

Hi, 

I have an LLC that holds the real estate and the other LLC is handling the management (getting rents, sending payments, etc.).

As I was preparing my taxes, my tax professional advised me that management LLC is redundancy and it doesn't make sense to have, it's like moving my money from one pocket to the other. The reason is since I am the owner of the LLC, it's income is reported in my personal taxes.

I was advised that if I want to separate the management from the property, the managing entity should be an incorporated. I was told if I want to have employees I need to operate an incorporation. 

Do LLC's not have employees?

This issue is coming every year, and a few tax pros I have talked to are not doing a good job explaining it.

Can someone shed some light on this?

[Stuart Udis]

@Davit Gharibyan They advised correctly, this adds no additional value and no additional liability protection, only additional expenses. I would drop the management entity and collect and operate your business through the deed holder LLC. The way you describe this is as a pass through entity which is sufficient and simplifies everything. In order to comment on the employee status, its helpful to understand more about your business, will send a direct message.

[Davit Gharibyan]

Stuart, thanks for the info. 

Let's say I have 10 properties, and they're each in their own LLC, would it not make sense to operate them from one management company, instead of running 10 different LLC's? In that case how would one handle it? Would it be better to create an incorporation for management?

I appreciate it.

[Stuart Udis]

Let's assume the rental income from these 10 properties is sufficient to cover the costs of a property manager and you opt to self manage as opposed to hire a 3rd party manager. You could theoretically create an LLC to provide property management functions on behalf of the 10 property portfolio and have a management contract between each property LLC and the management company where you will use management fees to cover the salary of the property managment staff member. I don't beleive its necessary to run rental payments or expenses through the management company, just a management fee sufficient to cover the Employee salary and management company operating expenses as you are otherwise creating unecessary accounting work. Keep in mind this would be merely for management purposes, adds no additional liability protection. Also important to have all contract management in order between property owner, management company and vendors/sub contractors who provide services. Also be mindful of the fact property management is generally viewed as a loss leader in the industry and many make the mistake of self managing through employees which costs more than hiring a 3rd party firm that has scale to offer mroe back office support, technology, in-house maintenance staff etc. Not to mention you are now paying workers compensation insurance, professional liability insurance, general liability insurance and other misc. expenses of operating a second business, so it really is dependent on the size of your operation and portfolio.

[Jay Thomas]

The guidance from your tax expert appears to be somewhat accurate, however there are certain details to take into account. There is no separate taxation for the LLC if you are the only owner of the single-member LLC that owns the real estate; instead, the LLC's gains or losses "pass through" to your personal tax return. A distinct LLC for management establishes a record-keeping division between property ownership and management activities, which may be useful for bookkeeping and upcoming audits, even though income still flows through to you. For better limited liability protection, incorporation may be more tempting, particularly if management activities expose you to greater risks, such as litigation involving employees. The important thing to remember is that LLCs can employ staff members and pay payroll taxes in accordance with that.

[Davit Gharibyan]

Quote from @Jay Thomas:

The guidance from your tax expert appears to be somewhat accurate, however there are certain details to take into account. There is no separate taxation for the LLC if you are the only owner of the single-member LLC that owns the real estate; instead, the LLC's gains or losses "pass through" to your personal tax return. A distinct LLC for management establishes a record-keeping division between property ownership and management activities, which may be useful for bookkeeping and upcoming audits, even though income still flows through to you. For better limited liability protection, incorporation may be more tempting, particularly if management activities expose you to greater risks, such as litigation involving employees. The important thing to remember is that LLCs can employ staff members and pay payroll taxes in accordance with that.

Hi Jay, I am using a separate LLC for record keeping and management activities. Additionally, the management software provider (Yardi), required to have a management entity and the way the software set up, it's having all rents/expenses going through one account which is tied to the management and not each property's account...
If I run each property separately, it'll create a mess logistically. 
I may take on tax person's advice and convert LLC to incorporation, since I'm thinking to expand the management side of business and manage properties for others. 

[David M.]

@Davit Gharibyan

I still don't see a reason to incorporate...

Sure, having a pair of single member LLC's, or even multi, doesn't change your taxation since they are pass through entities.

However, its been discussed many times about your setup providing some segmentation of the liability since the Mgt LLC is doing the lease (you'd create a PM-type contract between the Title holding entity and the mgt LLC). the Mgt LLC becomes the landlord, and the Title holding entity is basically fallow (except annual funds transfers since the Mgt LLC has to payout to its client sometime for a legality I think).

LLC's have employees. MANY major corporations are LLC's.

In some ways regardless, you should make sure your mgt LLC is properly licensed and insured. If you want to expand it to service others, it doesn't make sense to incorporate.

Hopefully you have competent tax professionals...  I know many layman equate the "disregarded" status by the IRS to also the corporate veil.  The "disregarded" status is just a tax status by the IRS which in practice means they didn't create another form.  e.g.  partnerships have their 1065 and C Corps have a whole another mess of files (don't know the number).  

Furthermore, electing to be taxed as a C Corp entirely changes your taxation, usually for the worse.  Oh, and are they suggesting you elect to be taxed as a C Corp?  Or, actually form a C Corp entity?  If the former, that's just stupid in my layman's opinion since its a taxation status, not an entity change.  If the latter, as mentioned I still don't understand why and you'll also incur so much expenses in operating the C Corp including getting a Board of Directors!

Good luck.

[Davit Gharibyan]

@David M. David, my logic is aligned with yours, but according to the tax guys I'm dealing with it's flawed. 

I better consult with more pros. 

[Michael Smythe]

@Davit Gharibyan whoever advised you to setup an PM LLC, didn't convey the right reason.

It's really NOT for additional protection.

What it does is make your monthly accounting easier!

You can have the PM LLC collect all rents & other income and pay all expenses from an Operating bank account and hold all security deposits in a separate account that meets your state's requirements. The remaining funds can be disbursed to your personal bank account.

Otherwise, you must have separate bank accounts (operating & security deposit) for each LLC that owns a property.

[Davit Gharibyan]

Quote from @Michael Smythe:

@Davit Gharibyan whoever advised you to setup an PM LLC, didn't convey the right reason.

It's really NOT for additional protection.

What it does is make your monthly accounting easier!

You can have the PM LLC collect all rents & other income and pay all expenses from an Operating bank account and hold all security deposits in a separate account that meets your state's requirements. The remaining funds can be disbursed to your personal bank account.

Otherwise, you must have separate bank accounts (operating & security deposit) for each LLC that owns a property.

That's exactly why I set up an LLC. However, according to tax pros it's not necessary...

[David M.]

@Davit Gharibyan who are your “tax pros?”  Actually lawyers and accountants??