Accounting Issue 2014

The Rise of the LLC [Updated]

How a once-obscure entity became ubiquitous in real estate

Last week, the developer RFR Holding broke ground on 610 Lexington Avenue, a condominium tower that will be next to the Seagram Building. RFR partnered with China Vanke, China’s biggest public developer, which took a stake in its first New York development.

A rendering of 610 Lexington Avenue

A rendering of 610 Lexington Avenue

RFR also filed a $180 million deed that transferred the property from 610 Lexington Avenue LLC to 610 Lexington Property LLC.

Both LLCs are tied to RFR, and the exact purpose of the transaction wasn’t clear. An RFR spokeswoman declined to comment. An executive at Ullico, the building’s mortgage lender, said the matter was “internal” and declined to comment further.

But RFR’s use of a limited liability company will allow Vanke, a foreign investor, to take a stake in the project, something that wouldn’t be possible if the building’s ownership was structured as an S Coporation. Such flexibility, along with other tax benefits, has made the LLC the tool of choice for New York developers when it comes to buying real estate.

The first LLC was formed in Wyoming in the 1970s, but the entity became popular after the IRS ruled in 1988 that the LLC would be treated as a partnership for tax purposes. In the case of New York City partnerships for real estate holdings, the LLC isn’t taxed, and the individual partners just pay personal income taxes, because real estate income in an LLC is a tax-exempt activity. The LLC can later decide to start paying corporation taxes if it wishes to go public and become, for instance, a real estate investment trust.

“It gives you flexibility,” said Meyer Mintz, a partner at accounting firm Berdon LLP. LLCs can be easily structured so that stakeholders have varying percentages of interest.

In contrast, C Corporations, which are typically used for public companies, are taxed twice, at the corporate level and when shareholders are taxed when they are issuing money. C Corporations and S Corporations also pay 8.85 percent corporate taxes in New York City.

LLCs also have an easier time pulling money out of a building through mortgages or refinancing, said Barry Horowitz, a partner of accounting firm WithumSmith+Brown PC. Partners don’t have to pay taxes or interest on money that comes from the property unless it is sold. “If you take money out, it’s taken out tax-free unless you sell,” said Mr. Horowitz. In contrast, corporations that take out additional financing require individual investors to pay interest on those loans.

One of the LLC’s biggest strengths is the “limited liability” nature of the company, which means that individual partners aren’t exposed to legal claims or creditors seeking additional assets if the building becomes financially troubled.

The only exception is when a partner agrees to a personal guarantee, which makes him or her liable for damages. This is rarely done but may happen if a developer is new to the business and the bank wants more reassurance, said David McKelvey, a tax partner with Friedman LLP.

Another quality of LLCs is that their operations agreements can vary, which can allow some partners to get more favorable terms.

“While there’s a core element in LLC operating agreements, they’re very customizable,” said Mr. McKelvey. “More sophisticated investors with better attorneys can end up in better positions.”

Some advantages of LLCs include the timing of profits, which will affect the scheduling of tax filings, said Mr. McKelvey.

LLCs can also be used to obscure a buyer’s identity, which can allow developers to distance themselves from controversial projects. Regular corporations can also hide individuals. But this feature is generally not the main reason for the prevalence of LLCs, Mr. McKelvey said, although some celebrity residential buyers have used single-partner LLCs to hide their penthouse purchases.

An attorney can set up an LLC for about $250 to $500, said Robert Gilman, the co-chair of Anchin, Block & Anchin LLP’s real estate group. The major expense is that the formation of an LLC has to be publicized in a weekly and daily newspaper, which can cost an additional $900 to $1,500. “It’s those sections of the paper that most people pass over,” said Mr. Gilman. But most landlords don’t have a problem with the expenses when they’re spending millions to buy a building.

A large increase in fees or new regulations could discourage investors from using LLCs, but New York City hasn’t made any moves to do that.

“The way things are now,” Mr. Gilman said, “I don’t foresee LLCs going away.”

Update: This story mistakenly identified 610 Lexington Avenue as being a condominium and hotel tower. It is just a condo.

Follow Roland Li via RSS.