Law favors reorganization of real estate holdings.
When properly organized, the LLC combines the liability protection of a corporation with the beneficial pass--through tax treatment of a partnership.
Not only will the paperwork for two companies be effectively eliminated, along with their attendant tax returns and reporting mechanisms, but most personal liability will also be removed.
"It's very important," said Dan Margulies, executive director of the Community Housing Improvement Program, an owner's group. "It's attractive from the liability structure. In the short-term people will be jumping on the bandwagon and in the long-run, will use it as a powerful tool for business organization and estate planning. It offers flexibility in terms of member's rights."
Under the new structure, there is also new terminology. In a LLC, the participants are called "Members," and rather than a General Partner, there is a "Managing Member." The LLCs conduct business pursuant to an operating agreement, which is similar to a partnership agreement.
Warren Wechsler, first senior vice president of the Real Estate Board of New York, said "It would seem to lighten the tax burdens and removes an additional layer of taxation since they are taxed as partnerships and not corporations. Individuals are also shielded from personal liability in the event assets are being pursued, so those two protections would make it very attractive."
The city and state made the transition easier in June when other legislation was passed permitting the tax-free transfer of assets from one entity to another with no change in actual ownership holdings.
According to Pamela Ehrenkranz, an attorney who is Special Counsel to Rosenman & Colin, the conversion was facilitated by these real estate transfer tax laws.
"So long as your percentage ownership doesn't shift, transferring real estate among entities is now a possibility without having the local transfer tax consequences," she said. "That's been one of the major stumbling blocks to getting complete limited liability to New York City real estate owners."
Mark Rudd, a partner with the law firm of Rudd, Rosenberg & Hollender who represents many building owners, said "The LLCs are a vehicle an individual building owner can utilize."
In signing the measure on July 26, Governor Mario M. Cuomo said the bill will help to attract businesses to New York State, particularly real estate and high technology businesses, venture capital firms, cooperative joint ventures and small businesses typically operated as sole proprietorships.
The law also permits partnerships to register as Limited Liability Partnerships (LLP), professional partnerships to register as Registered Limited Liability Partnerships (RLLP), and recognizes LLPs from other jurisdictions. New York is one of a handful of states that permits all of these entities to do business within a state.
Since the LLC/LLP measure goes into effect 90 days after its signing, experts believe real estate owners should begin to explore making these changes before the end of October, when the law will become effective.
Because New York was one of the last states to permit the LLCs - California and Pennsylvania being two noteworthy holdouts - some accounting firms are already familiar with this kind of operation.
"People will be getting up to speed," advised Margulies, whose group is holding a seminar on Lead Liability and LLC's on September 29th at the Park Central Hotel's Corinthian Room from 2 to 4 p.m., after its noon mini-trade show.
"There are no experts on this yet," said Margulies. "The people who are more familiar with this are owners who have properties in New Jersey and used the structure."
According to Ralph J. Anderson, CPA, the partner in charge of tax department for the New York and New Jersey offices of M.R. Weiser & Co., the law is good for two reasons. One reason is because now owners don't have to worry about personal liability. "In a general partnership you do have personal liability," he noted.
And two, for tax purposes, he said, the LLCs act like a partnership, which is much more favorable than a corporate tax structure.
When structuring property ownership under the current limited partnerships, oftentimes real estate operators set up general partners as corporations and then have the partnership become a limited partnership to protect the partners from liability.
"The one advantage the LLCs have is that there is no longer any personal liability whatsoever," explained Anderson. "Even with a general partner corporation you would still have the potential personal liability for the assets within the corporation. Within the general partnership, the General Partner has fiduciary obligation and potential personal liability."
Under current law, adds Ehrenkranz, "The general partner doesn't always get complete protection. Now you have the ability to protect that general partner."
Sam Starr, CPA, who is a tax partner in the national tax office of Coopers & Lybrand in Washington, said that a creditor of the entity, after exhausting all of the partnership's assets, can go after the personal assets of a General Partner.
"That's an extreme disadvantage if you are a GP," he said. "But you can choose to form your operation as an LLC and everybody now has limited liability. So outside creditors can go after limited liability assets but they can't penetrate and go after personal assets."
So under the LLC, if there is a mistake and someone is harmed or killed on the property, those who are wronged can only look to the asset or the building - if real estate - of that LLC. There is no looking for personal assets or assets from another entity, Anderson agreed. "What we've done," he said, "so you don't have the cross collateralization of the assets, is set up single asset limited liability companies."
While the managing members will have contractual obligations not to mismanage, advised Starr, in terms of fiduciary responsibility to the public-at-large, it will be a matter of regular tort liability.
"If someone falls on the classic banana peel, they can sue the LLC and seek redress against the LLC assets, but they can't go further against the personal assets," said Starr. But, he warned, depending on the state, "if you were very fraudulent or gross you could probably expose yourself."
The LLC structure also avoids having to set up the additional general partner corporation, so administratively, there is only one entity per building, and only one tax return.
Ehrenkranz said the change can be made with a one-page document and doesn't require going back to get new documents. "The partnership's existing document can function as the controlling document," she said. "And everyone would have to sign-off. It merely requires the filing of one piece of paper with the publication requirement."
The LLC is formed by filing articles of organization with the New York State Department of State and a copy of which, or a notice containing the substance of the articles, must be published once a week for six successive weeks in two newspapers, such as REW.
From a tax point of view, Anderson says there is no difference. "You are subject to the same partnership tax provisions," he explained. "It's very flexible, you can allocate profits, losses and distributions based on percentage of ownership or any reasonable manner."
John A. Fox, senior vice president of PKF Consulting, said "In the right circumstances and the right needs, it could be a big plus for the real estate community. It gives the benefits that were derived from being a partnership to an entity that then has the protection from legal liability that you get from a corporation."
In the LLCs, the members are not dealing with stock ownership but partnership interest. Because it is real estate and illiquid, an owner can set up an LLC and start gifting away ownership to members of the family at a substantial discount, Anderson explained.
"You could have probably done the same with 'S' corporations and general or limited partnerships, but now you are dealing with one entity and dealing with partnership provisions and not corporate provisions, and it makes it a lot easier," he added.
If the managing member wants to transfer ownership to children it is an excellent vehicle to transfer ownership and maintain managing member interest.
"You can start giving ownership away to children, but even with those giftings you can still control that entity," Anderson said. "That's why I like it as an entity which is better for estate purposes for taxes, rather than a general partnership. In a general partnership, you may be able to do the same, but then you are subjecting your family to personal liability. Under the LLCs you can have the managing members be the father or the mother, and the children can be non-managing members," he added.
The New York law will also precipitate welcomed international consequences. Because foreign investors can be Members, Anderson said, the LLC will become a great element in joint venture pools. Joint ventures can be formed with international companies where they could not with Sub S corporations due to the restriction of having foreign ownership and the limited liability of the corporate structure.
One of Anderson's New Jersey clients is about to sign an affiliation with a German company using the LLC structure, he said.
The use of the word "foreign" in the statute's legal-ese, he observed, is applicable to either another state or other country.
"If you were a Subchapter S, the LLC saves you potential built-in gains tax issues," Anderson said. "In addition, if you wanted a foreign investor, the 'S' status could be terminated because it was 'tainted' with foreign ownership."
Fox agreed the limitations imposed on being a Subchapter S corporation are essentially removed. "With the Sub S, there was a limit on the number, and a limit on foreign ownership," he said.
Additionally, Anderson noted, New York State is allowing single member LLCs, so that, for instance, a sole attorney, architect or CPA practitioner can take advantage of this law. Most of the professional corporations would be converting to RLLPs - Registered Limited Liability Partnerships.
David Nestor, a spokesperson for Coopers & Lybrand, said they registered the U.S. firm as a Limited Liability Partnership in the State of Delaware on August 1st.
"The New York law was one of the final pieces," he said. "We were able to do this because all jurisdictions now have provisions for accounting firms to do business as an LLP whether they are registered in that state or not." Ernst & Young and Price Waterhouse have also announced their conversion to LLPs.
Anderson estimates the cost for converting to an LLC on an entity by entity basis will probably run about $2,500 to $3,000 in professional fees for attorneys and accountants.
There is a one-time filing fee that is currently $200. Annual fees to the state and city each amount to a $325 minimum tax or $50 per member, with a maximum of $10,000. "You are looking at small fees with a great reward in exchanging the title of the property to an LLC," he said.
In most cases, Anderson added, "there is no transfer tax because New York now permits entities to be transferred with the same controlling interests, and there is no Gains Tax on these kinds of transfers."
Starr said under Federal laws, the LLC would be taxed at the 39.6 percent maximum rate and all the attributes of the operation would be passed on to the individual Members.
"Because this LLC is treated as a partnership," he said, "the passive activity loss rules will apply to the Members of the LLC, and if there is a particular member not participating, they will suspend LLC losses at the member level and not use them. So it's very comparable to a limited partner."
Warned Fox, "There are some wrinkles over wouldn't cause a termination of the old partnership and you won't have to recognize gains and losses. But if you are a corporation, you will have a termination. So it might be difficult."
Ehrenkranz said the conversion should be federal, state, local income and transfer tax-free, unless you are already holding in a Subchapter C or an S corporation.
Richard N. Runes, of counsel to Brown & Wood and counsel to the Corporations, Authorities & Commissions Committee headed by Senator John Daly, said the General Partner corporation could become a partner in the new LLC.
If an existing corporation wants to convert to an LLC, Starr noted that is a far more complex transaction. First, the in converting to a limited liability company. Since an LLC for purposes of taxation is the same as a partnership, changing company needs to liquidate, and then assets are passed to owners before the assets are put into the LLC.
"It can be costly from a tax perspective because you have to pay a liquidation tax," Starr said. "We are seeing very few existing corporations formed into LLCs. What we are finding, is that for a new business, a new office building, the LLC presents a strong alternative."
Andrew West, CPA, a real estate investor and partner in Segal & West Associates, said he didn't know if it was worthwhile at the moment for real estate groups to make the conversion. "The impression of most people is different than reality," he said. "But it will help professional service organizations, where there is a large professional liability."
Anderson says everyone has a different opinion on this. "It is our firm's belief there is no other way of doing business."
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|Title Annotation:||New York State and limited liability corporations|
|Publication:||Real Estate Weekly|
|Date:||Aug 24, 1994|
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