LLC structure for separate holding LLC's, property management LLC

[Ryan Vienneau]

Need help from the accountants out there, there are a lot of posts on this topic but none I could find that address this question and my CPA wasn't much help (may need a new CPA)...

I just moved my buy-and-hold rental from my personal name into an LLC as part of a commercial refi. I'm about to transact a multiple property deal where I will put each property into its own LLC. So, assume I will have 4 properties in 4 LLC's that are owned by me as sole member.

From multiple discussions I've had and reading posts here, I think I also want to form a 5th LLC to act as a management company, so that I can have one business account and credit card to collect all rent and pay all the overhead and expenses (paying for meals, PO box, RE licensing fees, etc). I'm also working to bring in some outside property management accounts that would operate there as well.

My question is, in this structure, what is the actual mechanism to account for cash flowing between the property management LLC and the holding LLC's? Does the property management LLC have to pass down to the holding LLC's the income left after paying expenses each month just like if I were managing someone else's properties? Does the management LLC bill for it's services? And if income passes into the holding LLC, what is the best practice for pulling that cash out to utilize for other purposes while preserving the veil and not commingling. (Example, property LLC #1 has $10k cash on balance sheet, but property LLC #2 has none and needs a $10k roof).

Here's an example:

This month Property LLC#1 receives $2000 in rent and incurs $600 in direct expenses for a cash flow of $1400. The management LLC needs to pay $300 for real estate licensing, and $200 for the phone bill. How does the money flow in this structure?

[Linda Weygant]

Ugh.  This is overly complicated, but I see why you're doing it.  Your greatest challenge is going to be running this management company without the appearance of co-mingling all of the LLCs together.

Bear in mind that one of the things that you'll be doing here is converting Passive Income to Earned Income via the Mgmt Company and that will be subject to self employment tax whereas had you left everything in the property LLCs, you'd have only passive income.  This may be a good strategy for you and I'm not advising against it in the slightest.  Just know that this is effectively what you are doing.

First of all, see if electing an S-Corp for the management company is right for you.  There may be some reasons why it's not and only a CPA, EA or Tax Attorney that understands your full picture will be able to offer good advice on that.

The Mgmt company will be it's own complete and separate entity with no ownership over any of the other LLCs.

You may choose to have an umbrella LLC over the LLCs that own the property, but that's not really necessary.

Set up your bookkeeping for the mgmt company.  Collect the rents as a fiduciary.  That is - this rent is NOT your income.  You collect it on behalf of your "clients", so you should follow whatever fiduciary rules are necessary in your state for that.  This is particularly important if/when you bring in other accounts to manage, so you may as well start off correctly in the beginning.

Pay the expenses associated with each property - again, as the fiduciary. This would be HOA fees, mortgages, utilities, repairs AND your property management fee. (Effectively you will sweep your property management fee from the fiduciary bank account to the Mgmt Company's operating account). The leftover cash flow will then go to the LLCs bank account (or the umbrella bank account, if you've chosen that structure). You will also provide your "client" with a statement that shows the rental income the property received along with the associated expenses you paid before sweeping the money over.

The Operating account of the Mgmt fee now has Property Management Revenue.  Out of that revenue, you pay for your licensing, phone, internet and other expenses necessary to run the management company.  If you've elected S- Status, this is also where you'll pay yourself a salary and payout the payroll taxes and anything else that goes along with that.  

Back in the umbrella LLCs, or other LLCs, you may have some other expenses that you didn't pay before you swept the funds over.  This could include an annual licensing fee from your municipality or a stray utility bill or whatever.  It's cool to pay additional expenses from here.  Once you've accumulated sufficient reserves for the property in this account, you can then use the excess cash balance to sweep over to your personal account as profit distributions.

The key here is keeping the entities separate.  I personally carry 7 debit cards that represent my 10 properties and it can be frustrating while you're standing in line at Home Depot flipping through your wallet to find the right one.  I've messed up a handful of times over the years, but an occasional misstep is not considered co-mingling as long as it is not frequent or habitual.

In this way, you'll preserve your entity protection and make your CPA happy at the end of the year with all the perfectly managed bank accounts and each property with its own reporting.