5/95 Percent Partnership For LLC with rental units

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5/95 Percent Partnership For LLC with rental units

Mike Jones
Member since 2020 · 82 posts · 4 votes

Hello,

Let say my brother, and I want to for a Holding LLC which will Owned a management LLC. I have 1 rental unit, and will be buying a second one, cash. The first property is on my name. planning on growing the business with more rental units, and possibly bigger deals.

My brother will own 5-10% and I will be own 90-95% of the business. Originally, I Was going to form a Single member with just me as the owner, but I am bringing my brother in because I want the LLC to fill a tax return so that few years from now it can help if i want to sale the properties or buy more properties as i will be acquiring more. He is not going to invest into the business, I am bringing him in just for the above reason (tax return for the LLC), hence why he's getting just 5%, and I can I go as low as 1% (if that wont raise a red flag to the IRS).

Now, I am not sure if we should be 5/95 percent partners on the Holding LLC, and Holding LLC with own 100% of the management LLC or I should be single member on HOlding LLC and he comes in as a member with 5% on the management LLC and the 95% be owned by my single memember HOlding LLC? He doesnt care how I structure it. I just want to know what would the pro and cons be with either structure.

I am also planning on getting portfolio loans down the road, and possibly do a cash out of the property that is 100% cash purchase.

Any issues i will run into ??

Any thought??

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  • Mike Jones
    OP
    Member since 2020 · 82 posts · 4 votes
    6y

    Here is an image to illustrate. Or should I have it with me 100% Owner of Holding LLC, then him and the Holding llc will own 10/90 on the management llc. The goal is to bring in partners on project base, so maybe keeping me at 100% on holding llc and having the partners on a different management llc make more sense.

    Any thoughts?

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    6y

    @Mike Jones

    Not sure exactly your proposed structure... your projects with investors will be other LLC/partnership with your holding LLC being one of the members, right? Meanwhile, your managing LLC is "contracted" by each project LLC to collect rents and pay expenses...

    Your brother's involvement depending on what sort of "cut" you want him to get. If at the Mgt LLC, he only gets the 5% of the operating income. If you sell a project, he doesn't get a cut of the proceeds

    Also, I don't get you logic on having a second person. I sort of get you are trying to avoid single member LLC which for federal purposes is a disregarded entity. If that is your approach, why not have him involved at both LLC? Or if your intent is to force a separate tax filing so it's not on your personal 1040, then he needs to be involved at the very top level so that your business returns flow into the final LLC to generate a k-1 to your 1040.

    That’s my laymen’s two cents

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  • Mike Jones
    OP
    Member since 2020 · 82 posts · 4 votes
    6y

    Thank you @David M. Sorry if i wasnt clear in my post. To clarify a little more:

    --- My brother won't take any cut as he will not be investing at all. I am using him just to be a multi member and generate a k-1 for tax. On the diagram above he owns        10% of the HOlding llc, which own 100% of the mgt llc. and yes, the mngt llc does collect rent.

    --- If and when I have to bring in a partner, we will form a new llc on which they will own x% and my holding llc will own y%.

    Again, I am bringing him on just to be a multi member and have to fill a return on the holding llc. I though that was going to be better long run. If I am wrong, then I can just do a single member on the holding llc and report on my personal 1040.

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    6y

    @Mike Jones

    Why do you want to be taxed as a partnership?

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  • Evan Polaski
    Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
    6y

    @Mike Jones, I think you are overthinking this too much.  Why does the property need to create its own tax returns?  Your properties will flow to a schedule E on your personal tax returns as is, and that can be sent as needed when selling.  You will not need to send your whole 1040 if someone wants to see tax returns with sale.

    When creating a partnership, it will pass through, but your brother will be taking a small percentage of your upside like depreciation, even if not receiving income.  Plus, you will be spending at least a couple hundred dollars per year in having a CPA generate and file a separate tax return.

    Really, I would talk to a real estate attorney and let them know what you are trying to achieve.  A good one will be able to advise you with the simplest structure to protect you and achieve the results you are looking for.

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  • Mike Jones
    OP
    Member since 2020 · 82 posts · 4 votes
    6y

    @David M. So that the llc can have a tax return, which I though would be good when trying to get Financing, unless am wrong.

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  • Mike Jones
    OP
    Member since 2020 · 82 posts · 4 votes
    6y

    @Evan Polaski thanks for the reply. I though a k-1 would be better when trying to get Financing. I am new to this and learning everyday.

    I have reached out to attorneys, and its a 300$ bill per hour. They can set it up whichever way i want it, but they cant tell me which setup will make it harder for me to get Financing etc. So I come here to get inputs from those who have been into this and understand it better. 

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  • Evan Polaski
    Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
    6y

    @Mike Jones I have a sole-member LLC and 6 units, 4 single families and a duplex. When I was getting commercial loans on my single families, they are underwriting me and my overall tax returns, without any issue.

    Generally, on small deals (i.e. single family, 4 plex, even likely 20 and under units) your lender will be a local or regional bank doing a balance sheet loan.  You cannot step up to agency until you are near $1mm in loan amount on a single property.  These lenders will still look back to you, no matter your structure and likely pull your credit and verify your income, even on the commercial side.  With single family, duplex, fourplex, one vacancy takes you from 100% to 75/50/0% occupancy, and likely your will be cash flow negative, hence why you are still being underwritten with a personal guaranty on the loan.

    Once you get into larger deals, then your credit and income are less important, as the asset is being underwritten.  BUT, you are not out of the picture.  At that point you need to show net worth and liquidity, as well as operating history for an asset that size OR have a professional PM lined up.

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  • Mike Jones
    OP
    Member since 2020 · 82 posts · 4 votes
    6y

    @Evan Polaski thanks man. I knew they would look at my credit and finances. I wanted to create the holding ll, mngt llc structure so that I can be as anonymous as possible but at the same time I don’t want to create a structure that will prevent me from getting loans. I believe they can still verify that I am the owner even if I structure it that way.

    I got sue two times and had to settle on both occasions. They could see what i owned a property that had a lot equity and knew they were getting paid. That is the man reason to why I wanted to structure it that way. Otherwise I would just have a single llc and have my name out there.

    Hopefully that makes sense and I am fully opened to other recommendations, and tricks.

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    6y

    @Mike Jones

    I think if you really want to separate your personal returns from review, you need to generate a W2.  So, your company has to be structured NOT as a pass-through entity and you need to take a salary.  I think that's how you keep the underwriters at bay from digging into your finances.

    Meanwhile for asset protection and anonymity, the LLCs don't always help with the latter depending on what state you are in/use.  My understanding the former also can vary in details by State.

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  • Evan Polaski
    Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
    6y

    @Mike Jones, you can still create these entities, but all as pass throughs.  It will still shield liability, if properly setup, and as long as your actions don't "pierce the corporate veil".  

    You could create a management LLC and a property LLC. Then draft and sign a management agreement between management LLC and property LLC. Both can be sole member LLCs to provide liability protections, but you will need to be very certain as to how you are signing all sort of things and operating.

    I would be more concerned as to why you were sued two times.  When you are starting to operate under various LLCs, if there is one slip up with how you sign you may be opening yourself back up to liability.  This is independent of any partnership structure with your brother, other than he will be added to the lawsuit too.

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  • Mike Jones
    OP
    Member since 2020 · 82 posts · 4 votes
    6y

    @David M. I will be forming in WY for the holding llc and MA for property llc.

    @Evan Polaski That i the setup I am going for. What type of things should i specify in the operating agreement between the two llc? Just curious.

    I will just make both of them single member llc and keep my brother out. WY llc will have the protection.

    Sure, I am planning on separating myself from the entities, otherwise they are useless. I have been reading and learning about how to accomplish that.

    One more question. With this setup, both llc will each have a bank account, the property llc will receive the rent, WHICH ONE will pay the bills?

    I am learning everyday, and I truly thank you guys for your inputs. 

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    6y

    @Mike Jones

    I believe you want the Mgt LLC to receive rents and pay the bills. Then, the proceeds flow to the holding LLC then to you. The individual LLC's holding the properties with the investors holds no cash. That's my understanding of how you separate the real asset from the liability of the operations and vice versa. The idea is something like they can only sue the property LLC if there is a problem with the property. More likely they will sue the Mgt LLC for some maintneca or lease issue and the only thing they can go after is whatever cash is on hand in the LLC (and maybe the rent roll)

    Just my two cents

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  • Mike Jones
    OP
    Member since 2020 · 82 posts · 4 votes
    6y

    @David M.

    Thats what I am also thinking. Mgt llc receive rent, pay bill then sends the rest of the cash (if any) to the holding llc.

    Now Let say i want to buy another property, and need to make a contribution, do I write a check to Holding llc thn from there will be sent the Mgt llc for the purchase, or just write a check to Mgt llc. My understanding is that I personally do not have a direct connection with the Mgt llc. 

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    6y

    @Mike Jones

    Right, you don't have a privity between yourself and the Mgt LLC. You only have privity to the Holding LLC. So, youd have to make a contribution to the Holding LLC who then makes a contribution to capitalize the new LLC that is purchasing the property. Just draw a tree diagram showing lines of ownership and that's how the money has to flow...

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  • Mike Jones
    OP
    Member since 2020 · 82 posts · 4 votes
    6y

    @David M. What about signing documents or contracts for the Mgt llc, do I sign them as the manager of the holding llc? How would that work? 

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    6y

    @Mike Jones

    You got me on how to sign once you've nested LLC's. I think you are referring to as a the member of the "first XYZ LLC," you'd sign "John Doe, Member, XYZ LLC." Since a company can't sign for itself and you need a real person, you MIGHT just nest the crap out of it to become "John Doe, Member, XYZ LLC, Member of ABC LLC." I am also guessing that you might have your attorney sign or the "bottom LLC" appoints yourself as an agent with authority to sign. So, you aren't an owner/member of that last LLC, but you have the authority to sign on behalf of... Anyway, this is definitely stuff that you need an experienced attorney help you structure.

    I never wanted to run a "massive" company and get this complicated.  I'd be buried in paperwork and never actually do work anymore...  :)

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    6y

    @Mike Jones

    https://www.quora.com/How-does-an-LLC-that-is-a-sole-member-of-another-LLC-sign-documents

    Just found the above. So basically, does sound like what I was thinking. You need to give yourself POA or some sort of authority to sign on behalf of the other LLC.

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  • Evan Polaski
    Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
    6y

    @Mike Jones, again, this is all for an attorney to answer based on your specific situation, various llc's etc.  And the more you entities you create and have to manage, the more bookkeeping time, corporate filing cost, and chance to mess something up an open yourself back up to liability.

    Management company is simply a contractor of the LLC that holds the property. So when you are signing a lease, a contract for work to be performed at the property, you are signing as the management company. The management company will collect rents and pay bills as mentioned. At some agreed to interval, typically by the 15th of the following month, you will distribute that cash, less any bills and management fee and leasing commissions, to the property LLC. If the various properties are all held in an umbrella holding LLC, they will distribute to the holding LLC. And you as sole owner of the holding LLC will take a distribution. So every month, you will be moving money 3 times for each property in order to get your hands on it.

    You, as the manager, will take a distribution from the management company, to get your hands on the management company income, after you paid bills.  Or if the management company is under the same umbrella holding company, mgmt llc to holding llc to you.

    When you are buying a new property, for the most protection, you will setup an acquisition LLC that signs the purchase contract, due diligence contracts etc. That way if something goes south, it is the acquisition LLC on the hook, and there are no assets in there. Generally, this sits outside of a holding company, so seller cannot flow up to holding LLC and then down to other assets. As you are about to close, you assign the contract from the acquisition LLC to the holding llc, which has been formed and has its own bank account now. That entity will take ownership and hold the property. It will also enlist your management company for management services (seperate contract signed at closing). Earnest deposit money for contract will be funded by you to acquisition entity. When you transfer contract to property LLC, you will fund money to holding company and holding company to property LLC, and also to acquisition LLC to reimburse for their deposit.

    With any movement of money, you will need to account for it, and keep solid records.

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    6y

    @Mike Jones

    @Evan Polaski So, Mr. Polaski can you please clarify a point for me? You are saying to hold title to the properties in the one Holding LLC?

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  • Evan Polaski
    Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
    6y

    @David M. I may have mistyped. For the most protection, it is typically recommended that each property sit in its own LLC. As Mike was stating, it sounds like he then wants those property level LLCs to flow up to a holding company LLC.

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    6y

    @Evan Polaski

    Okay, not questioning. Like I said just asking for clarification.

    Sounds like we have similar ideas. I just never heard of using an acquisition LLC for pre-closing purposes. Interesting...

    Anyway, in summary, use the acq LLC to start to segment pre-closing liability, then assign contract to LLC to ‘hold title.' This LLC holding title will be owned by the top level holding LLC. The mgt LLC sits on the "side" and has a contract with each "title

    Holding LLC' to collect rent, pay expenses, etc — have attorney work out.

    P.S. does the mgt LLC need a real estate broker ? Or if everything is really just one person the State will see all the LLC entities as serving himself so he doesn't need a broker license to operate under (I've haven't quite gotten the hang of the peculiarities of a property Managment company)

    Thanks

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  • Evan Polaski
    Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
    6y

    @David M., when talking with your attorney, I would ask them about the real estate license piece.  In Ohio, you need one to manage other people's properties, but not your own.  I would assume a sole member LLCs with the same owner would not need one, but that is something to ask a local real estate attorney.

    Again, the structure I outlined, in my opinion, is overkill if you are talking a handful of single families. I own 6 units and they are all under the same LLC, that I formed, and I have never had an issue.

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  • Mike Jones
    OP
    Member since 2020 · 82 posts · 4 votes
    6y

    @Evan Polaski

    Sorry I got lost here with management llc and acquisition.

    Basically here how things will flow:

    - Holding llc on top. Will be a Single member, manager managed.

    - Property Llc, single member, member managed. The member is the holding llc.

    Let say property llc has 2 rentals, and receive money every month. Those rents will be deposited to it account. Property llc will pay mortgage and all the bills. Any surplus will go to Holding llc.

    Let say the holding llc has enough cash and want to buy a 3rd property and house it in a new llc.

    Property llc #2 will be formed, single member, member managed. Holding llc being the member.

    Contracts will go as fallow:

    Property LLC#1

    By: Holding LLC, Managing member

    By: _______________

    Mike Jones, Manager

    Property LLC#2

    By: Holding LLC, Managing Member

    By:_________

    Mike Jones, Manager

    Manager Mike Jones can only write a contribution check to Holding llc. Then holding llc will move it to the property llc needing the money.

    If property llc#2 decide to sale the property in it, the money will go to it bank account, then property llc#2 will write a check to Holding llc.

    Etc.....

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    6y

    @Mike Jones

    https://www.biggerpockets.com/forums/52/topics/822035-multiple-bank-accounts-on-llcs-holding-structure-question?highlight_post=4834674&page=1#p4834674

    You should take a look at the above discussion thread.  Its very similar.  

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