Creating a Limited Liability Company (LLC) to Buy an Apartment Building

When purchasing an apartment building, an investor will more likely than not want to create a limited liability company (LLC) to purchase the property. In this post, I will cover the benefits and costs associated with an LLC (taxes and maintenance costs) as well as the documents that make up the foundation of an LLC.

In simple terms, an LLC is a business structure that you can create by yourself, with a partner, or with a group. If you own an LLC, you would be referred to as a “member.” This business structure is regulated at the state level, which means the process to create the LLC and the fees will differ. The benefits of owning an LLC include being able to limit personal liability, keeping properties separate from one another, pass-through taxation, and easily separating business and personal expenses.

The Benefits of an LLC

Limiting Personal Liability

If an investor were to buy an apartment building individually and someone were to file a lawsuit against them, they would be personally liable, and that investor’s assets would be at stake. With an LLC, the only assets that would be at stake are the assets owned by the LLC. In other words, the property would be the only asset at stake and not the investor’s personal assets. However, it’s important to know that in certain lawsuit cases, the limited personal liability benefit may not apply.

Keep Properties Separate

If an investor owns multiple properties, they can separate them by putting each property under an LLC. This allows an investor to insulate each individual property in the event that a lawsuit occurs. Thus, if a lawsuit pertaining to one of the properties occurs, the rest of the properties will not be affected.

Pass-through Taxation

An LLC with more than one member is a pass-through entity. What that means is that the LLC’s profits and losses pass through to the members which then pay personal income taxes on their fair share of the profits. The advantage of being taxed as a pass-through entity is that the LLC owner will not get taxed twice (once at the company level and again at the personal level).

Easily Separate Business and Personal Expenses

When an investor creates an LLC to buy an apartment building, they should create a separate bank account for the LLC. That way, the personal expenses of the individual and the business expenses are separated. This makes it easier to account for the operating expenses of the buildings. When it comes time to do taxes, the investor’s accountant will have an easy time filing taxes.

Documents

Articles of Organization

To establish an LLC, an investor must file a document titled “Articles of Organization” with the state agency responsible for business filings. This document is rather simple and typically contains the business name and address as well as the address of the individual who can receive lawsuits on the business’s behalf. Depending on the state, the articles could include the names of the owner(s) (members) or managers of the LLC in addition to the purpose of forming the entity. The filing fees typically run about $50 for legal services and $50 to upwards of $800 for a filing fee which of course depends on the state. To make things easier to remember, the full list of information that you’ll need to include in your Articles of Organization includes the following:

1. Business Name
2. Address of the LLC
3. Business Mailing Address
4. Business Purpose
5. Members’ and/or Managers’ names
6. The state law (this is usually pre-printed on the form)
7. Effective Date
8. Registered Agent’s details – this is the person who receives legal documents on behalf of your company
9. Duration of the LLC – can be perpetual of indefinite

Operating Agreement (OA)

An operating agreement is an internal document that describes how the investor’s LLC will run in addition to the roles and contributions of the owners (members) and the way decisions will be made. An investor can create their own operating agreement for free. However, if there are multiple members to the LLC then the investor will want to make sure to get professionals involved to make sure the process goes smoothly and the information is accurate. This document can be done by a legal service provider which typically will charge between $50 and $200 or you can hire a local lawyer to get this done. The details of the operating agreement will include the following:

1. General Character of Business – The purpose of the LLC
2. Separateness – (ex. I’ve seen: “The Company must conduct its business and operations in its own name and must maintain books and records and bank accounts separate from those of any other person.”)
3. Management – The person or entity that will manager the entity (i.e. the LLC)
4. Allocation of profit and loss – How the profits and losses will be split (ex: All distributions with respect to the Managing Member’s interest in the Company will be made 100.00% to the Managing Member)
5. Capital Contribution – Initial capital contribution going to the company
6. Dissolution– When the company will seize to exist
7. Fiscal Year– The year for taxing and accounting purposes (usually the calendar year)
8. Taxation as Partnership– (ex: The Company shall file its return with the Commissioner of Internal Revenue and any applicable state taxing authorities as a partnership and shall not elect to be taxable other than as a partnership without the consent of the Member)
9. Tax Matters Partner / Partnership Representative – This is the member of the partnership who is responsible for representing the business to the IRS in the fiscal year stated on the form. (ex: The Member is hereby designated the Tax Matters Partner for the purposes of Section 6231(a)(7)(B) of the Internal Revenue Code of 1986, as amended from time to time. The Tax Matters Partner shall comply with the responsibilities set forth in Sections 6221 through 6234 of the Code.)
10. No Liability of Member and Others – A statement spelling out that the members of an LLC are not personally liable for the debts of the company unless the Articles of Organization states otherwise or the members agree to be personally liable.
11. Indemnification – This is a statement saying that the LLC will hold harmless ant member, manager, or other person from any and all claims or demands whatsoever.
12. Amendment- Here in the operating agreement it states the Articles of Organization may be amended only by written agreement executed by the members.
13. Governing Law- This part of the OA states that the document will be interpreted and enforced in accordance with the state that it was filed with.

LLC Maintenance Costs

Similar to any person or entity, LLCs are subject to taxation. However, the government doesn’t take its cut directly from the LLC but rather collects the profits of the owners as a pass-through income. This is why LLCs are called pass-through entities, although that is only true when there is more than one member. Single-member LLCs are by default taxed as disregarded entities (a tax term that means that the LLC’s activities will reflect on its owner’s federal tax return). Most states tax LLC profits similarly to that of the federal government, profits pass through to members’ tax returns. Some states have mandatory LLC franchise taxes for example the franchise fee is Deleware is $300. More so, at the state government level, some LLCs may be subject to reporting fees. Reporting fees depend on the state and on average are somewhere around $100 per year. A positive that comes when starting an LLC is that certain startup costs (up to $5,000) can be written off including attorney fees, market research, office space, equipment, and more. In addition to these fees, a registered agent must be assigned which is the person who is the main point of contact between the LLC and the state. The registered agent accepts service of lawsuits and other legal documents and can accept office mail. Any adult can be a registered agent so long as they reside in the state in which teh LLC is registered and are available during business hours. The lack of restrictions around registered agents means that businesses don’t have to take on any costs to declare a registered agent. There are service providers that can serve as registered agents for $100 to $300 per year.

Conclusion

All this is to say that when an investor is looking to purchase an apartment building (or any real estate for that matter) they will want to open an LLC. More often than not there are multiple members who share the profits of the LLC based on the amount of equity they put into any given deal. The LLC guards the members against being personally liable in the event that a lawsuit is filed against the LLC. If this were not the case, the members of the LLC would be personally liable in the event that assets must be seized. An example of this is if the debt payments associated with the purchase of a building failed to be met. The bank would go after the LLC but since they cannot go after the members, their only choice is to take control of the asset. However, this would not apply in the event that the borrowers do not comply with the provisions spelled out within the loan documents (this is referred to as a “Bad-Boy Carve-Out“). Nevertheless, I trust this post helped explain the importance of opening up an LLC when purchasing real estate.

If you have any questions regarding the terms and concepts in this post or previous ones, don’t hesitate to reach out to either me (tedi.nati@jtacquisitions.com) or someone on our team so we can help explain what is causing the confusion. If you’re interested in investing with us at JT Acquisitions, you can contact us via email (contact@jtacquisitions.com), LinkedIn, Instagram, or our investor portal to set up a meeting.

As always, I hope you enjoyed reading this post as much as I have writing it. Best of luck!