Journey into Delaware: Setting Up an LLC for Holding Real Estate

As we continue our business expansion across the country, we are learning many things about setting up a business within each state, the differing laws across the states, and how best to structure our business within each state.

Here is our journey into Delaware and what we discovered while expanding our business into the first state.

The first thing we looked at when expanding our location was to identify a building to host it. The location must satisfy certain minimum criteria such as the city and street names, convenience factor, and transportation logistics. One of the most important factors was security. We wanted to make sure that the location we choose would be a safe place for our employees and a secure place to store our customers’ mail and packages. After careful consideration, we identified a building for purchase that fit our criteria in Claymont, Delaware.

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The biggest challenge after finding the location was to ensure that the building we purchased is protected from the higher risks associated with our operating company. An operating company carries a higher liability risk because it has more touch points with the external environment such as customers, vendors, and other third parties. The risk increases proportionally with the number of touch points.

In order to resolve our challenge, we evaluated multiple strategies. One of the recommended strategies, and the one we ultimately went with, is to have the real estate owned by a separate holding company. The holding company will then lease the building to our operating company. By doing it this way, the two companies are actually being run and treated as separate entities.

We also decided to establish the real estate holding company as an LLC for ease of administration and tax benefits.

How We Set Up a Limited Liability Company (LLC) in Delaware

An easy way to set up an LLC is to go through a legal service or lawyer, which will likely help you take care of the formation process and draft up the required documents.  However, we did not go this route.

Instead, we opted to do the research for ourselves and set up our own LLC.  Our reasoning was that the real estate holding company is a fairly simple entity. It would only hold and manage one property and have very few touch points with outsiders. It would have very few members, limited management duties and simple roles. Therefore, the Operating Agreement was simple and not overly complicated. It also didn’t hurt to understand how to set up an LLC so we can help answer questions that customers may have when they use our Registered Agent Services.

With that in mind, we began setting up our LLC. Our first step was to find the state website that handles corporate and business formations. In Delaware, this would be the Delaware Division of Corporations. It contains all the information you would need to do to set up a new business entity and the required registration fees.  

After careful examination, we found out that setting up a domestic LLC in Delaware has the following requirements:

  • A registered agent must be designated. You will actually need to get a registered agent first because the Certificate of Formation requires you to list the registered agent.

  • A Certificate of Formation is needed. A sample LLC Formation template is provided by the state that one can use.

  • A filing fee to be included with the Certificate of Formation. As of 2018, this fee is $90. If you wish to get a certified copy (a filed copy is already included as part of the filing fee), that’s an extra $50.  Expedited fees also cost extra. See the Corporate Filing Schedule for all the fees.

  • Include a Cover Letter Memo. This will contain information on where to mail your filed copies, whether you want to expedite the filing process, and the payment method to use.

  • Pay annual taxes due by June 1st of every year following the calendar year in which the Certificate of Formation becomes effective. As of 2018, this annual tax is $300.

The setup process for an LLC is actually not too difficult if you follow their instructions. However, we were concerned about a few things.

Things To Consider For Your LLC

  1. Certificate of Formation Content: We were concerned if the sample template offered was sufficient or if we needed to add more legal verbiage.  Due to our past experience with writing up the Articles of Incorporation when setting up our California corporation, we learned the lessons that taught us to be a bit more cautious about the language used in a formation document.
  2. Processing Time: The entire formation process cannot be completed online like Nevada. All documents must be mailed. This increases the processing time and must be taken into account if speed is a consideration for your business. For us, we actually needed the company to be formed within less than a month. Since we’re not sure how fast the normal processing time is going to take, we were looking at the 24-hour expedited option.
  3. Registered Agent Services: A registered agent is needed first because the Certificate of Formation requires you to list the registered agent. Since we are not yet physically in Delaware, we cannot be our own registered agent. Therefore, we needed to find a temporary registered agent service.

Registered Agent Services

We began our process by first searching for a registered agent service to use. Fees for registered agent services range from $40 - $200 or more. After much research, we found a solution to all our concerns.  We decided to go with Delaware Registered Agent to not only be our registered agent but also to form our LLC.  

Previously, we said we were going to go through the entire process ourselves. But after considering the factors above, we decided to use them to form our LLC for the following reasons:

  • Cost: The price to form the LLC for us was $180, which included one year of registered agent service. If we were to do this ourselves, it would cost us $90 for the LLC filing fee and $45 for this registered agent annual fee. The $45 difference would be the service fee we pay, which we considered to be reasonable.
  • Speed: They are located in Dover and can submit our filing documents and complete the registration in a day. It would have taken us more time and cost us more to mail out the forms ourselves using Express Overnight plus the 24-hour expedited fee (which was $50 as of 2018).
  • Convenience: They completed the Certificate of Formation for us along with a sample Operating Agreement to use. With this, we were able to see how they actually filled out the Certificate of Formation.  While we didn’t use their Operating Agreement, it may be something that others may have found useful as a reference.
  • Privacy: As an added bonus, the signatory and name on the Certificate of Formation is a person from them and not our own name. While it is not a highly important factor for us, the protection in our privacy is a plus since our own personal name is not listed on the document and available as public record. It may be a critical factor for those who are looking to protect their assets though, so if that’s an important factor, then you will definitely need to make use of a third party to form your entity.

After signing up for the registered agent service, we were able to get our LLC formed in a day. It was an extremely smooth and seamless process. While the legal set up of the LLC was completed at this point, we still have other things that needed to be prepared.

Opening a Bank Account

Having a separate bank account for the business is extremely important and recommended. It allows you to track your income and expenses separately. Mixing personal and business funds and spending also leads to a higher chance for litigators to pierce the veil and go after the owners directly.

To set up a bank account, we must first obtain an Employer Identification Number (EIN) from the IRS. If you have a social security number (SSN) or tax identification number (TIN), then you can simply apply for an EIN online and obtain the number immediately. If you do not have an SSN or TIN, then you would need to either get someone (ie. your CPA) who does to apply or submit the application for EIN by mail.

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The bank also requires a physical business address for the business in order to open a business bank account.  Some banks only accept a commercial business address while others may accept a residential address (in the case of a home-based business). For us, we already have our own commercial address locations, so this requirement was easy to fulfill.

The bank will also require an Operating Agreement for your LLC so they know you are an authorized manager or member that can act on behalf of the company. While Delaware does not legally require you to have an Operating Agreement, it is always recommended that you have one. For this, we used a copy of the Operating Agreement from one of other previously formed LLCs. We then updated it and then had it reviewed by our lawyer.  

Tip: Having a lawyer review the documents will usually cost less than having one drafted up for you.

With all these documents and the Certificate of Formation, we opened up the bank account without issue.

Business Licenses and Taxes

Based off of Delaware’s Business License FAQ, any person or business conducting a trade or business in the State of Delaware is required to obtain a Delaware business license from the Delaware Division of Revenue. This includes entities located in Delaware who conduct their business outside the state.

The business license fee is dependent on the tax category for your business. For our real estate holding company, the business license fee is $75 for the first location and $25 for each additional location. We technically have no location for our holding company, but will still need to pay the $75. The license is generally good for one year and expires each December 31st. The business license fee can be paid online, so that part is at least easier and more convenient.  

In addition to the business license fee, Delaware also has a Gross Receipts Tax for Commercial Real Estate Lessor. To summarize the relevant tax for this:

  • There is a $100,000 monthly exclusion ($300,000 per quarter) from the gross receipts tax for your sales. This means that if our rental income is less than $300,000 per quarter, then our gross receipts tax is $0. 
    • Anything over the monthly exclusion amount is taxed at 0.3983%. 
  • New licenses will file on a quarterly basis through their first calendar year. Later, a look back procedure will be performed and the filing frequency may be changed. 
    • For monthly filers, the tax is due on the 20th day of the following month. 
    • For quarterly filers, the tax is due on the last day of the first month after the end of the calendar quarter. 
  • There are some exemptions to the gross receipts tax. For example, gross receipts from transactions between related entities are not subject to the gross receipts tax. Entities are “related” only if (1) the same 5 or fewer natural individuals own, directly, indirectly, or beneficially, 80% or more of each entity; or (2) 100% of each entity is owned by member(s) of a single family. As an example, if our operating company and holding company are owned by the same people, then the rent paid from the operating company to the holding company is exempt from the tax.

The State of Delaware offers a One Stop website where you can register your business with the Division of Revenue, the Division of Unemployment Insurance, and the Office of Workers Compensation. Here, you can quickly register and obtain a business license and pay for business license fees online.

 

Insurance

One of the most important and often overlooked things to do is obtaining property and liability insurance. Insurance is highly recommended and often required if you happen to use a loan to purchase a property. At a minimum, we usually get the Owners Property and Liability Insurance (OPLI). This combines both property and liability into one single insurance policy for a lower cost. It will handle both property related issues as well as liability issues should certain accidents happen on the property.

Note: Get a good insurance agent to help you with this. Any good agent will be able to explain the details and what it is you need to stay protected.

Conclusion

Starting up a new business is not for the faint of heart. It is even more complicated when you have to set up presence in multiple states. For us, forming the LLC is actually not the most difficult part. Instead, it is all the post-setup and annual maintenance tasks that cause more headaches. Hence, we want to document our expansion into Delaware so you can learn something from it.

We will continue to post more articles about our journeys as we grow our business.  Stay tuned for the next one!

Do You Need a Certificate of Formation to Form a LLC? 

Are you unsure of what to put on your Certificate of Formation? We have created a Certificate of Formation Template to help you file for your LLC. Download our Certificate of Formation Template.

Download Certificate of Formation Template