10-K 1 k264-08.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934 For the Fiscal Year Ended: December 31, 2008 Commission file number: 000-51823 AEI INCOME & GROWTH FUND 26 LLC (Exact name of registrant as specified in its charter) State of Delaware 41-2173048 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 30 East 7th Street, Suite 1300, St. Paul, Minnesota 55101 (Address of principal executive offices) (651) 227-7333 (Registrant's telephone number) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered None None Securities registered pursuant to Section 12(g) of the Act: Limited Liability Company Units (Title of class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No [X] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes No [X] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filer Accelerated filer Non-accelerated filer Smaller reporting company [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No [X] As of June 30, 2008, there were 1,832,736.0 Units of limited membership interest outstanding and owned by nonaffiliates of the registrant, which Units had an aggregate market value (based solely on the price at which they were sold since there is no ready market for such Units) of $18,327,360. DOCUMENTS INCORPORATED BY REFERENCE The registrant has not incorporated any documents by reference into this report. PART I ITEM 1. BUSINESS. AEI Income & Growth Fund 26 LLC (the "Company" or the "Registrant") is a limited liability company which was organized pursuant to the laws of the State of Delaware on March 14, 2005. The registrant is comprised of AEI Fund Management XXI, Inc. (AFM), as the Managing Member, Robert P. Johnson, the President and sole director of AFM, as the Special Managing Member, and purchasers of LLC Units as Limited Members. The Company offered for sale up to $100,000,000 of limited membership interests (the "Units") (10,000,000 Units at $10 per Unit) pursuant to a registration statement effective October 20, 2005. The Company commenced operations on April 3, 2006 when minimum subscriptions of 150,000 LLC Units ($1,500,000) were accepted. The offering terminated October 19, 2007 when the extended offering period expired. The Company received subscriptions for 1,832,736 LLC Units. Under the terms of the Operating Agreement, the Limited Members and Managing Members contributed funds of $18,327,360 and $1,000, respectively. The Company was organized to acquire existing and newly constructed commercial properties, to lease such properties to tenants under net leases, to hold such properties and to eventually sell such properties. From subscription proceeds, the Company purchased eight properties, including partial interests in five properties, at a total cost of $15,376,536. The balance of the subscription proceeds was applied to organization and syndication costs, working capital reserves and distributions, which represented a return of capital. The properties are commercial, single tenant buildings leased under net leases. The Company's properties were purchased without any indebtedness. The Company will not finance properties in the future to obtain proceeds for new property acquisitions. If it is required to do so, the Company may incur short-term indebtedness to finance day-to-day cash flow requirements (including cash flow necessary to repurchase Units). The Company may borrow to finance the refurbishing of a property. The Company will hold its properties until the Managing Members determine that the sale or other disposition of the properties is advantageous in view of the Company's investment objectives. In deciding whether to sell properties, the Managing Members will consider factors such as potential appreciation, net cash flow and income tax considerations. The Company expects to sell some or all of its properties prior to its final liquidation and to reinvest the proceeds from such sales in additional properties. The Company reserves the right, at the discretion of the Managing Members, to either distribute proceeds from the sale of properties to the Members or to reinvest such proceeds in additional properties, provided that sufficient proceeds are distributed to the Limited Members to pay federal and state income taxes related to any taxable gain recognized as a result of the sale. It is anticipated that the Company will commence liquidation through the sale of its remaining properties ten to twelve years after completion of the acquisition phase, depending upon the then current real estate and money markets, the economic climate and the income tax consequences to the Members. ITEM 1. BUSINESS. (Continued) Leases Although there are variations in the specific terms of the leases, the following is a summary of the general terms of the Company's leases. The properties are leased to various tenants under net leases, classified as operating leases. Under a net lease, the tenant is responsible for real estate taxes, insurance, maintenance, repairs and operating expenses for the property. For some leases, the Company is responsible for repairs to the structural components of the building. At the time the properties were acquired, the remaining primary lease terms varied from 10 to 20 years. The leases provide the tenants with three to four five-year renewal options subject to the same terms and conditions as the primary term. The leases provide for base annual rental payments, payable in monthly installments, and contain rent clauses which entitle the Company to receive additional rent in future years based on stated rent increases. Major Tenants During 2008, five tenants each contributed more than ten percent of the Company's total rental revenue. The major tenants in aggregate contributed 85% of total rental revenue in 2008. It is anticipated that, based on minimum rental payments required under the leases, each major tenant, except for Red Robin International, Inc., will continue to contribute more than ten percent of rental revenue in 2009 and future years. Also, TSA Stores, Inc. will likely not continue to be a major tenant as the Company is attempting to sell the property it leases. Any failure of these major tenants could materially affect the Company's net income and cash distributions. Competition The Company is a minor factor in the commercial real estate business. There are numerous entities engaged in the commercial real estate business which have greater financial resources than the Company. At the time the Company elects to dispose of its properties, it will be in competition with other persons and entities to find buyers for its properties. Employees The Company has no direct employees. Management services are performed for the Company by AEI Fund Management, Inc., an affiliate of AFM. ITEM 1A. RISK FACTORS. Not required for a smaller reporting company. ITEM 1B. UNRESOLVED STAFF COMMENTS. Not required for a smaller reporting company. ITEM 2. PROPERTIES. Investment Objectives The Company's investment objectives are to acquire existing or newly-developed commercial properties that provide (i) regular rental income; (ii) growth in lease income through rent escalation provisions; (iii) capital growth through appreciation in the value of properties; (iv) reduced occupancy risks as a result of long-term leases with creditworthy corporate tenants; and (v) passive income that may be offset by eligible passive losses from other investments for tax purposes. The Company does not have a policy, and there is no limitation, as to the amount or percentage of assets that may be invested in any one property. However, to the extent possible, the Managing Members attempt to diversify the type and location of the properties. Description of Properties The Company's properties are commercial, single tenant buildings. The properties were acquired on a debt-free basis and are leased to various tenants under net leases, classified as operating leases. The Company holds an undivided fee simple interest in the properties. The Company's properties are subject to the general competitive conditions incident to the ownership of single tenant investment real estate. Since each property is leased under a long-term lease, there is little competition until the Company decides to sell the property. At this time, the Company will be competing with other real estate owners, on both a national and local level, in attempting to find buyers for the properties. In the event of a tenant default, the Company would be competing with other real estate owners, who have property vacancies, to attract a new tenant to lease the property. The Company's tenants operate in industries that are very competitive and can be affected by factors such as changes in regional or local economies, seasonality and changes in consumer preference. The following table is a summary of the properties that the Company acquired and owned as of December 31, 2008. Total Property Annual Annual Purchase Acquisition Lease Rent Per Property Date Costs Tenant Payment Sq. Ft. Sports Authority Store Wichita, KS 4/3/06 to (40%) 6/30/06 $2,230,753 TSA Stores, Inc. $204,665 $ 9.79 Advance Auto Parts Store Middletown, OH Advance Stores (55%) 6/1/06 $1,022,289 Company, Inc. $ 71,679 $18.94 Applebee's Restaurant 9/21/06 to Apple Indiana Indianapolis, IN 12/1/06 $3,054,187 II LLC $220,262 $42.12 Applebee's Restaurant Crawfordsville, IN Apple Indiana (40%) 12/29/06 $1,237,771 II LLC $ 89,289 $42.44 ITEM 2. PROPERTIES. (Continued) Total Property Annual PurchaseAcquisition Lease Annual Rent Property Date Costs Tenant Payment Per Sq. Ft. Starbucks Store Starbucks Bluffton, IN 8/10/07 $1,150,116 Corporation $ 79,800 $44.16 Red Robin Beavercreek, OH Red Robin (land only) 12/28/07 $1,533,655 International, Inc.$105,000 $ 1.18 Best Buy Store Eau Claire, WI Best Buy (30%) 1/31/08 $2,021,162 Stores, L.P. $142,222 $10.01 Dick's Sporting Goods Fredericksburg, VA Dick's Sporting (27%) 5/8/08 $3,126,603 Goods, Inc. $219,445 $16.69 The properties listed above with a partial ownership percentage are owned with affiliates of the Company. The remaining interest in the Sports Authority store is owned by AEI Income & Growth Fund 25 LLC. The remaining interest in the Advance Auto Parts store is owned by AEI Income & Growth Fund 24 LLC. The remaining interest in the Applebee's restaurant in Crawfordsville, Indiana is owned by AEI Income & Growth Fund XXII Limited Partnership. The remaining interests in the Best Buy store are owned by AEI Income & Growth Fund XXI Limited Partnership and AEI Income & Growth Fund 23 LLC. The remaining interests in the Dick's Sporting Goods store are owned by AEI Income & Growth Fund 23 LLC, AEI Income & Growth Fund 24 LLC and AEI Income & Growth Fund 25 LLC. The Company accounts for properties owned as tenants-in- common with affiliated entities and/or unrelated third parties using the proportionate consolidation method. Each tenant-in- common owns a separate, undivided interest in the properties. Any tenant-in-common that holds more than a 50% interest does not control decisions over the other tenant-in-common interests. The financial statements reflect only this Company's percentage share of the properties' land, building and equipment, liabilities, revenues and expenses. At the time the properties were acquired, the remaining primary lease terms varied from 10 to 20 years. The leases provide the tenants with three to four five-year renewal options subject to the same terms and conditions as the primary term. Pursuant to the lease agreements, the tenants are required to provide proof of adequate insurance coverage on the properties they occupy. The Managing Members believe the properties are adequately covered by insurance and consider the properties to be well-maintained and sufficient for the Company's operations. ITEM 2. PROPERTIES. (Continued) For tax purposes, the Company's properties are depreciated under the Modified Accelerated Cost Recovery System (MACRS). The largest depreciable component of a property is the building which is depreciated, using the straight-line method, over 39 years. The remaining depreciable components of a property are personal property and land improvements which are depreciated, using an accelerated method, over 5 and 15 years, respectively. Since the Company has tax-exempt Members, the Company is subject to the rules of Section 168(h)(6) of the Internal Revenue Code which requires a percentage of the properties' depreciable components to be depreciated over longer lives using the straight-line method. In general, the federal tax basis of the properties for tax depreciation purposes will be the same as the basis for book depreciation purposes. At December 31, 2008, all properties listed above were 100% occupied. ITEM 3. LEGAL PROCEEDINGS. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCK- HOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. (a) As of December 31, 2008, there were 453 holders of record of the registrant's LLC Units. There is no other class of security outstanding or authorized. The registrant's Units are not a traded security in any market. During the period covered by this report, the Company did not sell any equity securities that are not registered under the Securities Act of 1933. Cash distributions of $29,758 and $20,870 were made to the Managing Members and $962,192 and $674,790 were made to the Limited Members for 2008 and 2007, respectively. The distributions were made on a quarterly basis and represent Net Cash Flow, as defined, and a partial return of contributed capital. These distributions should not be compared with dividends paid on capital stock by corporations. (b) Not Applicable. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCK- HOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. (c) Beginning in January 2009, pursuant to Section 7.7 of the Operating Agreement, each Limited Member has the right to present Units to the Company for purchase by submitting notice to the Managing Member during January or July of each year. The purchase price of the Units is equal to 85% of the net asset value per Unit, as of the first business day of January or July of each year, as determined by the Managing Member in accordance with the provisions of the Operating Agreement. The purchase price is equal to 100% of the net asset value per Unit in the case of Units of a deceased investor, who purchased the Units in the initial offering and who is a natural person, including Units held by an investor that is an IRA or other qualified plan for which the deceased person was the primary beneficiary, or Units held by an investor that is a grantor trust for which the deceased person was the grantor. Units tendered to the Company during January and July are redeemed on April 1st and October 1st, respectively, of each year subject to the following limitations. The Company will not be obligated to purchase in any year more than 2% of the total number of Units outstanding on January 1 of such year. In no event shall the Company be obligated to purchase Units if, in the sole discretion of the Managing Member, such purchase would impair the capital or operation of the Company. During the last three months of 2008, the Company did not purchase any Units. Other Information The Company is required, pursuant to FINRA Rule 2810, to disclose in each annual report distributed to Limited Members a per Unit estimated value, the method by which it was developed and the date of the data used to develop the estimated value. During the Company's offering and for the three years after completion of the offering (through December 2010), the value of a Unit will be deemed to be $10.00. This deemed value is based solely on the offering price, without regard to the assets and liabilities of the Company, the cash flow of the Company, or any other valuation factors. However, please note that there is no public trading market for the Units nor is one ever expected to develop and there can be no assurance that Limited Members could receive $10 per unit if such a market did exist and they sold their Units or that they will be able to receive such amount for their Units in the future. In addition, the Company has not performed an evaluation of the Company properties and, therefore, this valuation is not based upon the value of the Company properties, nor does it represent the amount Limited Members would receive if the Company properties were sold and the proceeds distributed to the Limited Members in a liquidation of the Company, which amount would most likely be less than $10 per Unit as a result of the fact that, at the time the Company is purchasing its properties, the amount of funds available for investment in properties is approximately 15% less than the offering proceeds due to the payment of organization and offering expenses, including selling commissions, as described in more detail in the Company's Prospectus. ITEM 6. SELECTED FINANCIAL DATA. Not required for a smaller reporting company. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. This section contains "forward looking statements" which represent management's expectations or beliefs concerning future events, including statements regarding anticipated application of cash, expected returns from rental income, growth in revenue, the sufficiency of cash to meet operating expenses, rates of distribution, and other matters. These, and other forward looking statements, should be evaluated in the context of a number of factors that may affect the Company's financial condition and results of operations, including the following: Market and economic conditions which affect the value of the properties the Company owns and the cash from rental income such properties generate; the federal income tax consequences of rental income, deductions, gain on sales and other items and the effects of these consequences for Members; resolution by the Managing Members of conflicts with which they may be confronted; the success of the Managing Members of locating properties with favorable risk return characteristics; the effect of tenant defaults; and the condition of the industries in which the tenants of properties owned by the Company operate. Application of Critical Accounting Policies The preparation of the Company's financial statements requires management to make estimates and assumptions that may affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Management evaluates these estimates on an ongoing basis, including those related to the carrying value of real estate and the allocation by AEI Fund Management, Inc. of expenses to the Company as opposed to other funds they manage. The Company purchases properties and records them in the financial statements at cost (including capitalized acquisition expenses). The Company anticipates that for acquisitions completed on or after January 1, 2009, acquisition-related transaction costs will be expensed as incurred as a result of the adoption of Statement of Financial Accounting Standards No. 141(R), Business Combinations. The Company tests long-lived assets for recoverability when events or changes in circumstances indicate that the carrying value may not be recoverable. For properties the Company will hold and operate, management determines whether impairment has occurred by comparing the property's probability-weighted cash flows to its current carrying value. For properties held for sale, management determines whether impairment has occurred by comparing the property's estimated fair value less cost to sell to its current carrying value. If the carrying value is greater than the realizable value, an impairment loss is recorded to reduce the carrying value of the property to its realizable value. Changes in these assumptions or analysis may cause material changes in the carrying value of the properties. AEI Fund Management, Inc. allocates expenses to each of the funds they manage primarily on the basis of the number of hours devoted by their employees to each fund's affairs. They also allocate expenses at the end of each month that are not directly related to a fund's operations based upon the number of investors in the fund and the fund's capitalization relative to other funds they manage. The Company reimburses these expenses subject to detailed limitations contained in the Operating Agreement. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS. (Continued) Management of the Company has discussed the development and selection of the above accounting estimates and the management discussion and analysis disclosures regarding them with the managing member of the Company. Results of Operations For the year ended December 31, 2008, the Company recognized rental income from continuing operations of $838,939, representing twelve months rent from five properties and rent from two properties acquired during the period. For the year ended December 31, 2007, the Company recognized rental income from continuing operations of $413,705, representing twelve months rent from three properties and rent from two properties acquired during the period. For the years ended December 31, 2008 and 2007, the Company incurred LLC administration expenses from affiliated parties of $191,343 and $117,958, respectively. These administration expenses include costs associated with the management of the properties, processing distributions, reporting requirements and communicating with the Limited Members. During the same periods, the Company incurred LLC administration and property management expenses from unrelated parties of $25,863 and $18,126, respectively. These expenses represent direct payments to third parties for legal and filing fees, direct administrative costs, outside audit costs, taxes, insurance and other property costs. As the Company raised additional subscription proceeds and purchased additional properties, the administration and property management expenses increased. For the years ended December 31, 2008 and 2007, the Company recognized interest income of $74,599 and $163,247, respectively. In 2008, interest income decreased due to the Company having less money invested in a money market account due to property acquisitions and lower money market interest rates in 2008, when compared to 2007. These decreases were partially offset by additional interest received on construction advances in 2008. In accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, upon complete disposal of a property or classification of a property as Real Estate Held for Sale, the Company includes the operating results and sale of the property in discontinued operations. In addition, the Company reclassifies the prior periods' operating results of the property to discontinued operations. For the year ended December 31, 2008, the Company recognized income from discontinued operations of $190,252 representing rental income less property management expenses. For the year ended December 31, 2007, the Company recognized income from discontinued operations of $135,992 representing rental income less property management expenses and depreciation. The Company is attempting to sell the Sports Authority store in Wichita, Kansas. At December 31, 2008 and 2007, the property was classified as Real Estate Held for Sale with a book value of $2,126,435. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS. (Continued) Management believes inflation has not significantly affected income from operations. Leases may contain rent increases, based on the increase in the Consumer Price Index over a specified period, which will result in an increase in rental income over the term of the leases. Inflation also may cause the real estate to appreciate in value. However, inflation and changing prices may have an adverse impact on the operating margins of the properties' tenants, which could impair their ability to pay rent and subsequently reduce the Net Cash Flow available for distributions. Liquidity and Capital Resources The Company's primary sources of cash are proceeds from the sale of Units, interest income, rental income and proceeds from the sale of property. Its primary uses of cash are investment in real properties, payment of expenses involved in the sale of Units, the management of properties, the organization and administration of the Company, and the payment of distributions. The Company generated $851,975 of cash from operations during the year ended December 31, 2008, representing net income of $600,530 and a non-cash expense of $286,054 for depreciation, which were partially offset by $34,609 in net timing differences in the collection of payments from the tenants and the payment of expenses. The Company generated $637,819 of cash from operations during the year ended December 31, 2007, representing net income of $405,758 and a non-cash expense of $232,428 for depreciation, which were partially offset by $367 in net timing differences in the collection of payments from the tenants and the payment of expenses. The major components of the Company's cash flow from investing activities are investments in real estate and proceeds from the sale of real estate. During the year ended December 31, 2008, the Company expended $3,735,326 to invest in real properties (inclusive of acquisition expenses). On January 31, 2008, the Company purchased a 30% interest in a Best Buy store in Eau Claire, Wisconsin for $2,021,162. Also during the period, the Company paid $1,714,164, including acquisition expenses, for the construction of the Dick's Sporting Goods store in Fredericksburg, Virginia. During the year ended December 31, 2007, the Company expended $4,096,210 to invest in real properties (inclusive of acquisition expenses). On August 10, 2007, the Company purchased a Starbucks store in Bluffton, Indiana for $1,150,116. On December 28, 2007, the Company purchased land in Beavercreek, Ohio for $1,533,655. On December 17, 2007, the Company purchased a 27% interest in a parcel of land in Fredericksburg, Virginia for $1,412,439, including acquisition expenses. Simultaneous with the purchase of the land, the Company entered into a Project Construction and Development Financing Agreement under which the Company advanced funds for the construction of a Dick's Sporting Goods store on the site. During the offering of Units, the Company's primary source of cash flow was from the sale of LLC Units. The Company commenced the offering of LLC Units to the public through a registration statement that became effective October 20, 2005 and continued until October 19, 2007, when the extended offering period expired. The Company raised a total of $18,327,360 from the sale of 1,832,736 Units. From subscription proceeds, the Company paid organization and syndication costs (which constitute a reduction of capital) of $2,706,815. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS. (Continued) After completion of the acquisition phase, the Company's primary use of cash flow is distribution and redemption payments to Members. The Company declares its regular quarterly distributions before the end of each quarter and pays the distribution in the first week after the end of each quarter. For the years ended December 31, 2008 and 2007, the Company declared distributions of $991,950 and $695,660, respectively, which were allocated 97% to the Limited Members and 3% to the Managing Members. Beginning in April 2009, the Company may acquire Units from Limited Members who have tendered their Units to the Company. Such Units may be acquired at a discount. The Company will not be obligated to purchase in any year more than 2% of the total number of Units outstanding on January 1 of such year. In no event shall the Company be obligated to purchase Units if, in the sole discretion of the Managing Member, such purchase would impair the capital or operation of the Company. The continuing rent payments from the properties should be adequate to fund continuing distributions and meet other Company obligations on both a short-term and long-term basis. The Economy and Market Conditions The impact of conditions in the current economy, including the turmoil in the credit markets, has adversely affected many real estate companies. However, the absence of mortgage financing on the Company's properties eliminates the risks of foreclosure and debt-refinancing that can negatively impact the value and distributions of leveraged real estate companies. Nevertheless, a prolonged economic downturn may adversely affect the operations of the Company's tenants and their cash flows. If a tenant were to default on its lease obligations, the Company's income would decrease, its distributions would likely be reduced and the value of its properties might decline. The Company's plan was to periodically sell properties to generate capital gains that would be included in the Company's regular quarterly distributions and to make special distributions on occasion. Beginning in the fourth quarter of 2008, general economic conditions caused the volume of property sales to slow dramatically for all real estate sellers. In 2008, the Company did not complete any property sales and may have difficulty completing a property sale in 2009. Until property sales occur, quarterly distributions going forward will reflect the distribution of net core rental income and capital reserves, if any. Distribution rates in 2009 are expected to be variable and less than historical distribution rates until such time as economic conditions allow the Company to begin selling properties at acceptable prices and generating gains for distribution. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not required for a smaller reporting company. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See accompanying index to financial statements. AEI INCOME & GROWTH FUND 26 LLC INDEX TO FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm Balance Sheet as of December 31, 2008 and 2007 Statements for the Years Ended December 31, 2008 and 2007: Income Cash Flows Changes in Members' Equity (Deficit) Notes to Financial Statements REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Members: AEI Income & Growth Fund 26 LLC St. Paul, Minnesota We have audited the accompanying balance sheet of AEI Income & Growth Fund 26 LLC (a Delaware limited liability company) as of December 31, 2008 and 2007 and the related statements of income, cash flows and changes in members' equity for the years then ended. The Company's management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of AEI Income & Growth Fund 26 LLC as of December 31, 2008 and 2007, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. /s/ Boulay, Heutmaker, Zibell & Co. P.L.L.P. Certified Public Accountants Minneapolis, Minnesota March 26, 2009 AEI INCOME & GROWTH FUND 26 LLC BALANCE SHEET DECEMBER 31 ASSETS 2008 2007 CURRENT ASSETS: Cash $ 388,653 $ 4,249,562 Receivables 2,283 4,102 ----------- ----------- Total Current Assets 390,936 4,253,664 ----------- ----------- INVESTMENTS IN REAL ESTATE: Land 5,294,367 4,629,110 Buildings and Equipment 7,851,416 4,781,347 Accumulated Depreciation (497,187) (211,133) ----------- ----------- 12,648,596 9,199,324 Real Estate Held for Sale 2,126,435 2,126,435 ----------- ----------- Net Investments in Real Estate 14,775,031 11,325,759 ----------- ----------- Total Assets $15,165,967 $15,579,423 =========== =========== LIABILITIES AND MEMBERS' EQUITY CURRENT LIABILITIES: Payable to AEI Fund Management, Inc. $ 28,015 $ 90,239 Distributions Payable 247,987 233,595 Unearned Rent 25,796 0 ----------- ----------- Total Current Liabilities 301,798 323,834 ----------- ----------- MEMBERS' EQUITY (DEFICIT): Managing Members (21,717) (9,975) Limited Members, $10 per Unit; 10,000,000 Units authorized; 1,832,736 Units issued and outstanding 14,885,886 15,265,564 ----------- ----------- Total Members' Equity 14,864,169 15,255,589 ----------- ----------- Total Liabilities and Members' Equity $15,165,967 $15,579,423 =========== =========== The accompanying Notes to Financial Statements are an integral part of this statement. AEI INCOME & GROWTH FUND 26 LLC STATEMENT OF INCOME FOR THE YEARS ENDED DECEMBER 31 2008 2007 RENTAL INCOME $ 838,939 $ 413,705 EXPENSES: LLC Administration - Affiliates 191,343 117,958 LLC Administration and Property Management - Unrelated Parties 25,863 18,126 Depreciation 286,054 171,102 ----------- ----------- Total Expenses 503,260 307,186 ----------- ----------- OPERATING INCOME 335,679 106,519 OTHER INCOME: Interest Income 74,599 163,247 ----------- ----------- INCOME FROM CONTINUING OPERATIONS 410,278 269,766 Income from Discontinued Operations 190,252 135,992 ----------- ----------- NET INCOME $ 600,530 $ 405,758 =========== =========== NET INCOME ALLOCATED: Managing Members $ 18,016 $ 12,173 Limited Members 582,514 393,585 ----------- ----------- $ 600,530 $ 405,758 =========== =========== INCOME PER LLC UNIT: Continuing Operations $ .22 $ .20 Discontinued Operations .10 .10 ----------- ----------- Total $ .32 $ .30 =========== =========== Weighted Average Units Outstanding 1,832,736 1,327,999 =========== =========== The accompanying Notes to Financial Statements are an integral part of this statement. AEI INCOME & GROWTH FUND 26 LLC STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31 2008 2007 CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 600,530 $ 405,758 Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities: Depreciation 286,054 232,428 (Increase) Decrease in Receivables 1,819 (4,102) Increase (Decrease) in Payable to AEI Fund Management, Inc. (62,224) 3,735 Increase in Unearned Rent 25,796 0 ----------- ----------- Total Adjustments 251,445 232,061 ----------- ----------- Net Cash Provided By Operating Activities 851,975 637,819 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Investments in Real Estate (3,735,326) (4,096,210) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Capital Contributions from Limited Members 0 9,506,092 Organization and Syndication Costs 0 (1,399,799) Distributions Paid to Members (977,558) (549,984) ----------- ----------- Net Cash Provided By (Used For) Financing Activities (977,558) 7,556,309 ----------- ----------- NET INCREASE (DECREASE) IN CASH (3,860,909) 4,097,918 CASH, beginning of year 4,249,562 151,644 ----------- ----------- CASH, end of year $ 388,653 $ 4,249,562 =========== =========== The accompanying Notes to Financial Statements are an integral part of this statement. AEI INCOME & GROWTH FUND 26 LLC STATEMENT OF CHANGES IN MEMBERS' EQUITY (DEFICIT) FOR THE YEARS ENDED DECEMBER 31 Limited Member Managing Limited Units Members Members Total Outstanding BALANCE, December 31, 2006 $ (1,278) $ 7,440,476 $ 7,439,198 882,126.8 Capital Contributions 0 9,506,092 9,506,092 950,609.2 Organization and Syndication Costs 0 (1,399,799) (1,399,799) Distributions Declared (20,870) (674,790) (695,660) Net Income 12,173 393,585 405,758 --------- ----------- ---------- ----------- BALANCE, December 31, 2007 (9,975) 15,265,564 15,255,589 1,832,736.0 Distributions Declared (29,758) (962,192) (991,950) Net Income 18,016 582,514 600,530 --------- ----------- ---------- ----------- BALANCE, December 31, 2008 $ (21,717) $14,885,886 $14,864,169 1,832,736.0 ========= =========== =========== =========== The accompanying Notes to Financial Statements are an integral part of this statement. AEI INCOME & GROWTH FUND 26 LLC NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2008 AND 2007 (1) Organization - AEI Income & Growth Fund 26 LLC ("Company"), a Limited Liability Company, was formed on March 14, 2005 to acquire and lease commercial properties to operating tenants. The Company's operations are managed by AEI Fund Management XXI, Inc. ("AFM"), the Managing Member. Robert P. Johnson, the President and sole director of AFM, serves as the Special Managing Member. AFM is a wholly owned subsidiary of AEI Capital Corporation of which Mr. Johnson is the majority shareholder. AEI Fund Management, Inc. ("AEI"), an affiliate of AFM, performs the administrative and operating functions for the Company. The terms of the offering call for a subscription price of $10 per LLC Unit, payable on acceptance of the offer. The Company commenced operations on April 3, 2006 when minimum subscriptions of 150,000 LLC Units ($1,500,000) were accepted. The offering terminated October 19, 2007, when the extended offering period expired. The Company received subscriptions for 1,832,736 Units. Under the terms of the Operating Agreement, the Limited Members and Managing Members contributed funds of $18,327,360 and $1,000, respectively. The Company shall continue until December 31, 2055, unless dissolved, terminated and liquidated prior to that date. During operations, any Net Cash Flow, as defined, which the Managing Members determine to distribute will be distributed 97% to the Limited Members and 3% to the Managing Members. Distributions to Limited Members will be made pro rata by Units. Any Net Proceeds of Sale, as defined, from the sale or financing of properties which the Managing Members determine to distribute will, after provisions for debts and reserves, be paid in the following manner: (i) first, 99% to the Limited Members and 1% to the Managing Members until the Limited Members receive an amount equal to: (a) their Adjusted Capital Contribution plus (b) an amount equal to 6.5% of their Adjusted Capital Contribution per annum, cumulative but not compounded, to the extent not previously distributed from Net Cash Flow; (ii) any remaining balance will be distributed 90% to the Limited Members and 10% to the Managing Members. Distributions to the Limited Members will be made pro rata by Units. For tax purposes, profits from operations, other than profits attributable to the sale, exchange, financing, refinancing or other disposition of property, will be allocated 97% to the Limited Members and 3% to the Managing Members. Net losses from operations will be allocated 99% to the Limited Members and 1% to the Managing Members. AEI INCOME & GROWTH FUND 26 LLC NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2008 AND 2007 (1) Organization - (Continued) For tax purposes, profits arising from the sale, financing, or other disposition of property will be allocated in accordance with the Operating Agreement as follows: (i) first, to those Members with deficit balances in their capital accounts in an amount equal to the sum of such deficit balances; (ii) second, 99% to the Limited Members and 1% to the Managing Members until the aggregate balance in the Limited Members' capital accounts equals the sum of the Limited Members' Adjusted Capital Contributions plus an amount equal to 6.5% of their Adjusted Capital Contributions per annum, cumulative but not compounded, to the extent not previously allocated; (iii) third, the balance of any remaining gain will then be allocated 90% to the Limited Members and 10% to the Managing Members. Losses will be allocated 99% to the Limited Members and 1% to the Managing Members. The Managing Members are not required to currently fund a deficit capital balance. Upon liquidation of the Company or withdrawal by a Managing Member, the Managing Members will contribute to the Company an amount equal to the lesser of the deficit balances in their capital accounts or 1.01% of the total capital contributions of the Limited Members over the amount previously contributed by the Managing Members. (2) Summary of Significant Accounting Policies - Financial Statement Presentation The accounts of the Company are maintained on the accrual basis of accounting for both federal income tax purposes and financial reporting purposes. Accounting Estimates Management uses estimates and assumptions in preparing these financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions may affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could differ from those estimates. The Company regularly assesses whether market events and conditions indicate that it is reasonably possible to recover the carrying amounts of its investments in real estate from future operations and sales. A change in those market events and conditions could have a material effect on the carrying amount of its real estate. Cash Concentrations of Credit Risk The Company's cash is deposited in one financial institution and at times during the year it may exceed FDIC insurance limits. AEI INCOME & GROWTH FUND 26 LLC NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2008 AND 2007 (2) Summary of Significant Accounting Policies - (Continued) Receivables Credit terms are extended to tenants in the normal course of business. The Company performs ongoing credit evaluations of its customers' financial condition and, generally, requires no collateral. Receivables are recorded at their estimated net realizable value. The Company follows a policy of providing an allowance for doubtful accounts; however, based on historical experience, and its evaluation of the current status of receivables, the Company is of the belief that such accounts will be collectible in all material respects and thus an allowance is not necessary. Accounts are considered past due if payment is not made on a timely basis in accordance with the Company's credit terms. Receivables considered uncollectible are written off. Income Taxes The income or loss of the Company for federal income tax reporting purposes is includable in the income tax returns of the Members. In general, no recognition has been given to income taxes in the accompanying financial statements. The tax return and the amount of distributable Company income or loss are subject to examination by federal and state taxing authorities. If such an examination results in changes to distributable Company income or loss, the taxable income of the members would be adjusted accordingly. Real Estate The Company's real estate is leased under net leases, classified as operating leases. The leases provide for base annual rental payments payable in monthly installments. The Company recognizes rental revenue according to the terms of the individual leases. For leases that contain stated rental increases, the increases are recognized in the year in which they are effective. Contingent rental payments are recognized when the contingencies on which the payments are based are satisfied and the rental payments become due under the terms of the leases. The Company purchases properties and records them at cost. The Company compares the carrying amount of its properties to the estimated probability-weighted future cash flows expected to result from the property and its eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the property, the Company recognizes an impairment loss by the amount by which the carrying amount of the property exceeds the fair value of the property. AEI INCOME & GROWTH FUND 26 LLC NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2008 AND 2007 (2) Summary of Significant Accounting Policies - (Continued) The Company has capitalized as Investments in Real Estate certain costs incurred in the review and acquisition of the properties. The costs were allocated to the land, buildings and equipment. The buildings and equipment of the Company are depreciated using the straight-line method for financial reporting purposes based on estimated useful lives of 25 years and 5 years, respectively. In accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, upon complete disposal of a property or classification of a property as Real Estate Held for Sale, the Company includes the operating results and sale of the property in discontinued operations. In addition, the Company reclassifies the prior periods' operating results of the property to discontinued operations. The Company accounts for properties owned as tenants-in- common with affiliated entities and/or unrelated third parties using the proportionate consolidation method. Each tenant-in-common owns a separate, undivided interest in the properties. Any tenant-in-common that holds more than a 50% interest does not control decisions over the other tenant-in-common interests. The financial statements reflect only this Company's percentage share of the properties' land, building and equipment, liabilities, revenues and expenses. The Company's properties are subject to environmental laws and regulations adopted by various governmental entities in the jurisdiction in which the properties are located. These laws could require the Company to investigate and remediate the effects of the release or disposal of hazardous materials at these locations if found. For each property, an environmental assessment is completed prior to acquisition. In addition, the lease agreements typically strictly prohibit the production, handling, or storage of hazardous materials (except where incidental to the tenant's business such as use of cleaning supplies) in violation of applicable law to restrict environmental and other damage. Environmental liabilities are recorded when it is determined the liability is probable and the costs can reasonably be estimated. There were no environmental issues noted or liabilities recorded at December 31, 2008 and 2007. Fair Value Measurements Statement of Financial Accounting Standard No. 157 "Fair Value Measurements" ("SFAS 157") defines fair value, outlines a framework for measuring fair value, details the required disclosures and was effective January 1, 2008. SFAS 157's requirements for certain nonfinancial assets and liabilities recognized or disclosed at fair value on a nonrecurring basis are deferred until fiscal years beginning after November 15, 2008. AEI INCOME & GROWTH FUND 26 LLC NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2008 AND 2007 (2) Summary of Significant Accounting Policies - (Continued) Under SFAS 157, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date in the principal or most advantageous market. SFAS 157 establishes a hierarchy in determining the fair value of an asset or liability. The fair value hierarchy has three levels of inputs, both observable and unobservable. SFAS 157 requires the utilization of the lowest possible level of input to determine fair value. Level 1 inputs include quoted market prices in an active market for identical assets or liabilities. Level 2 inputs are market data, other than Level 1, that are observable either directly or indirectly. Level 2 inputs include quoted market prices for similar assets or liabilities, quoted market prices in an inactive market, and other observable information that can be corroborated by market data. Level 3 inputs are unobservable and corroborated by little or no market data. The Company has no assets or liabilities measured at fair value on a recurring basis that would require disclosure under this pronouncement. When testing for recoverability of properties under SFAS No.144, Accounting for the Impairment or Disposal of Long- Lived Assets, the provisions of this statement are used when comparing fair value to carrying value. Recently Issued Accounting Pronouncements In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141 (revised 2007), "Business Combinations" ("SFAS 141(R)"), which establishes principles and requirements for how an acquirer shall recognize and measure in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree, and any goodwill acquired in a business combination. Additionally, SFAS 141(R) requires that an acquirer must immediately expense all acquisition costs and fees associated with an acquisition. SFAS 141(R) became effective on January 1, 2009. We expect the adoption of SFAS 141(R) to have an impact on our results of operations to the extent properties are acquired in 2009 and future years. Acquisition expenses, which are currently capitalized as Investments in Real Estate, will instead be expensed immediately as incurred. Post acquisition, there will be a subsequent positive impact on operations through a reduction in depreciation expense over the estimated life of the properties. AEI INCOME & GROWTH FUND 26 LLC NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2008 AND 2007 (3) Related Party Transactions - The Company owns the percentage interest shown below in the following properties as tenants-in-common with the affiliated entities listed: Sports Authority store (40% - AEI Income & Growth Fund 25 LLC); Advance Auto Parts store (55% - AEI Income & Growth Fund 24 LLC); Applebee's restaurant in Crawfordsville, Indiana (40% - AEI Income & Growth Fund XXII Limited Partnership); Best Buy store (30% - AEI Income & Growth Fund XXI Limited Partnership and AEI Income & Growth Fund 23 LLC); and Dick's Sporting Goods store in Fredericksburg, Virginia (27% - AEI Income & Growth Fund 23 LLC, AEI Income & Growth Fund 24 LLC and AEI Income & Growth Fund 25 LLC). AEI, AFM and AEI Securities, Inc. ("ASI") received the following compensation and reimbursements for costs and expenses from the Company: Total Incurred by the Company for the Years Ended December 31 2008 2007 a.AEI and AFM are reimbursed for all costs incurred in connection with managing the Company's operations, maintaining the Company's books and communicating with the Limited Members. $ 195,300 $ 117,958 ======== ======== b.AEI and AFM are reimbursed for all direct expenses they have paid on the Company's behalf to third parties relating to LLC administration and property management. These expenses included printing costs, legal and filing fees, direct administrative costs, outside audit costs, taxes, insurance and other property costs. $ 36,319 $ 22,372 ======== ======== c.AEI is reimbursed for all costs and direct expenses incurred by it in acquiring properties on behalf of the Company. $ 46,076 $ 111,937 ======== ======== d.ASI was the underwriter of the Company's offering. AEI Capital Corporation is the sole stockholder of ASI, which is a member of the Financial Industry Regulatory Authority (FINRA). ASI received, as underwriting commissions,10% for sale of certain subscription Units (a majority of this amount was re-allowed to other participating broker/dealers). These costs are treated as a reduction of members' capital. $ 0 $ 924,494 ======== ======== e.AEI is reimbursed for all costs incurred in connection with managing the Company's offering and organization. $ 0 $ 295,906 ======== ======== AEI INCOME & GROWTH FUND 26 LLC NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2008 AND 2007 (3) Related Party Transactions - (Continued) Total Incurred by the Company for the Years Ended December 31 2008 2007 f.AEI is reimbursed for all direct expenses it has paid on the Company's behalf to third parties relating to the offering and organization of the Company. These expenses included printing costs, legal and filing fees, direct administrative costs, underwriting costs and due diligence fees. $ 0 $ 179,398 ======== ======== The payable to AEI Fund Management, Inc. represents the balance due for the services described in 3a, b, c, e and f. This balance is non-interest bearing and unsecured and is to be paid in the normal course of business. (4) Investments in Real Estate - The Company leases its properties to various tenants under net leases, classified as operating leases. Under a net lease, the tenant is responsible for real estate taxes, insurance, maintenance, repairs and operating expenses for the property. For some leases, the Company is responsible for repairs to the structural components of the building. At the time the properties were acquired, the remaining primary lease terms varied from 10 to 20 years. The leases provide the tenants with three to four five-year renewal options subject to the same terms and conditions as the primary term. The Company's properties are commercial, single-tenant buildings. The Sports Authority store was constructed in 1996, renovated in 2001 and acquired in 2006. The Advance Auto Parts store was constructed in 2004 and acquired in 2006. The Applebee's restaurant in Indianapolis, Indiana was constructed in 1997 and acquired in 2006. The Applebee's restaurant in Crawfordsville, Indiana was constructed in 1996 and acquired in 2006. The Starbucks restaurant was constructed and acquired in 2007. The land for the Dick's Sporting Goods store was acquired in 2007 and construction of the store was completed in 2008. The Best Buy store was constructed in 1990, renovated in 1997 and acquired in 2008. There have been no costs capitalized as improvements subsequent to the acquisitions. AEI INCOME & GROWTH FUND 26 LLC NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2008 AND 2007 (4) Investments in Real Estate - (Continued) The cost of the properties not held for sale and related accumulated depreciation at December 31, 2008 are as follows: Buildings and Accumulated Property Land Equipment Total Depreciation Advance Auto Parts, Middletown, OH $ 112,315 $ 909,974 $ 1,022,289 $ 94,031 Applebee's, Indianapolis, IN 889,340 2,164,847 3,054,187 191,986 Applebee's, Crawfordsvlle, IN 337,353 900,418 1,237,771 72,034 Starbucks, Bluffton, IN 344,008 806,108 1,150,116 44,336 Red Robin, Beavercreek, OH 1,533,655 0 1,533,655 0 Best Buy, Eau Claire, WI 474,137 1,547,025 2,021,162 56,724 Dick's Sporting Goods, Fredericksburg, VA 1,603,559 1,523,044 3,126,603 38,076 --------- --------- ---------- -------- $5,294,367 $7,851,416 $13,145,783 $ 497,187 ========= ========= ========== ======== On August 10, 2007, the Company purchased a Starbucks store in Bluffton, Indiana for $1,150,116. The property is leased to Starbucks Corporation under a Lease Agreement with a remaining primary term of 10 years and initial annual rent of $79,800. In July 2008, Starbucks announced that it was closing this store at the end of July. Starbucks has contacted the Company to attempt to negotiate an agreement to terminate the Lease. Unless an agreement is reached, the Company expects Starbucks to comply with all of its Lease obligations. On December 17, 2007, the Company purchased a 27% interest in a parcel of land in Fredericksburg, Virginia for $1,374,913. The Company obtained title to the land in the form of an undivided fee simple interest in the 27% interest purchased. Simultaneous with the purchase of the land, the Company entered into a Project Construction and Development Financing Agreement under which the Company advanced funds to Silver-Honaker Development Company, LLC ("Silver") for the construction of a Dick's Sporting Goods store on the site. The Company's share of the total acquisition costs, including the cost of the land, was $3,126,603. The property is leased to Dick's Sporting Goods, Inc. under a Lease Agreement with a primary term of 10 years and initial annual rent of $219,445 for the interest purchased. Pursuant to the Lease, the tenant commenced paying rent on May 8, 2008. Pursuant to the development agreement, for the period from December 17, 2007 through May 7, 2008, Silver paid the Company interest at a rate of 6.75% on the purchase price of the land and the amounts advanced for construction of the store. Pursuant to the Lease, any improvements to the land during the term of the Lease become the property of the Company. AEI INCOME & GROWTH FUND 26 LLC NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2008 AND 2007 (4) Investments in Real Estate - (Continued) On December 28, 2007, the Company purchased 2.04 acres of land in Beavercreek, Ohio for $1,533,655. The land is leased to Red Robin International, Inc. under a Lease Agreement with a remaining primary term of 11.3 years and initial annual rent of $105,000. Red Robin International, Inc. operates a Red Robin restaurant on the site. Ownership of the building and improvements will transfer to the Company upon termination of the lease. On January 31, 2008, the Company purchased a 30% interest in a Best Buy store in Eau Claire, Wisconsin for $2,021,162. The property is leased to Best Buy Stores, L.P. under a Lease Agreement with a remaining primary term of 10 years and initial annual rent of $142,222 for the interest purchased. For properties owned as of December 31, 2008, the minimum future rent payments required by the leases are as follows: 2009 $ 1,140,237 2010 1,142,862 2011 1,148,666 2012 1,189,119 2013 1,201,276 Thereafter 8,513,087 ---------- $14,335,247 ========== There were no contingent rents recognized in 2008 and 2007. (5) Major Tenants - The following schedule presents rent revenue from individual tenants, or affiliated groups of tenants, who each contributed more than ten percent of the Company's total rent revenue for the years ended December 31: Tenants Industry 2008 2007 Apple American Group Restaurant $ 309,551 $ 309,551 TSA Stores, Inc. Retail 204,665 201,564 Dick's Sporting Goods, Inc. Retail 142,167 N/A Best Buy Stores, L.P. Retail 130,742 N/A Red Robin International, Inc. Restaurant 105,000 N/A Advance Stores Company, Inc. Retail N/A 71,679 ---------- ---------- Aggregate rent revenue of major tenants $ 892,125 $ 582,794 ========== ========== Aggregate rent revenue of major tenants as a percentage of total rent revenue 85% 95% ========== ========== AEI INCOME & GROWTH FUND 26 LLC NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2008 AND 2007 (6) Discontinued Operations - The Company is attempting to sell the Sports Authority store in Wichita, Kansas. At December 31, 2008 and 2007, the property was classified as Real Estate Held for Sale with a book value of $2,126,435. The financial results for this property are reflected as Discontinued Operations in the accompanying financial statements. The following are the results of discontinued operations for the years ended December 31: 2008 2007 Rental Income $ 204,665 $ 201,564 Property Management Expenses (14,413) (4,246) Depreciation 0 (61,326) --------- --------- Income from Discontinued Operations $ 190,252 $ 135,992 ========= ========= (7) Members' Capital - For the years ended December 31, 2008 and 2007, the Company declared distributions of $991,950 and $695,660, respectively. The Limited Members received distributions of $962,192 and $674,790 and the Managing Members received distributions of $29,758 and $20,870 for the years, respectively. The Limited Members' distributions represent $0.53 and $0.51 per LLC Unit outstanding using 1,832,736 and 1,327,999 weighted average Units in 2008 and 2007, respectively. The distributions represent $0.32 and $0.30 per Unit of Net Income and $0.21 and $0.21 per Unit of return of contributed capital in 2008 and 2007, respectively. Beginning in April 2009, the Company may acquire Units from Limited Members who have tendered their Units to the Company. Such Units may be acquired at a discount. The Company will not be obligated to purchase in any year more than 2% of the total number of Units outstanding on January 1 of such year. In no event shall the Company be obligated to purchase Units if, in the sole discretion of the Managing Member, such purchase would impair the capital or operation of the Company. AEI INCOME & GROWTH FUND 26 LLC NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2008 AND 2007 (8) Income Taxes - The following is a reconciliation of net income for financial reporting purposes to income reported for federal income tax purposes for the years ended December 31: 2008 2007 Net Income for Financial Reporting Purposes $ 600,530 $ 405,758 Depreciation for Tax Purposes Under Depreciation for Financial Reporting Purposes 43,269 78,721 Income Accrued for Tax Purposes Over Income for Financial Reporting Purposes 25,796 0 --------- --------- Taxable Income to Members $ 669,595 $ 484,479 ========= ========= The following is a reconciliation of Members' Equity for financial reporting purposes to Members' Equity reported for federal income tax purposes for the years ended December 31: 2008 2007 Members'Equity for Financial Reporting Purposes $14,864,169 $15,255,589 Depreciation for Tax Purposes Under Depreciation for Financial Reporting Purposes 154,701 111,432 Income Accrued for Tax Purposes Over Income for Financial Reporting Purposes 25,796 0 Organization and Syndication Costs Treated as Reduction of Capital for Financial Reporting Purposes 2,691,997 2,691,997 ---------- ---------- Members' Equity for Tax Reporting Purposes $17,736,663 $18,059,018 ========== ========== ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. ITEM 9AT.CONTROLS AND PROCEDURES. (a) Disclosure Controls and Procedures. Under the supervision and with the participation of management, including its President and Chief Financial Officer, the Managing Member of the Company evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")). Based upon that evaluation, the President and Chief Financial Officer of the Managing Member concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in applicable rules and forms and that such information is accumulated and communicated to management, including the President and Chief Financial Officer of the Managing Member, in a manner that allows timely decisions regarding required disclosure. (b) Internal Control Over Financial Reporting. (i) Management's Report on Internal Control Over Financial Reporting. The Managing Member, through its management, is responsible for establishing and maintaining adequate internal control over our financial reporting, as defined in Rule 13a- 15(f) under the Exchange Act, and for performing an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2008. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management of the Managing Member; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company's assets that could have a material effect on the financial statements. Management of the Managing Member performed an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2008 based upon criteria in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Based on our assessment, management of the Managing Member determined that our internal control over financial reporting was effective as of December 31, 2008 based on the criteria in Internal Control-Integrated Framework issued by the COSO. ITEM 9AT.CONTROLS AND PROCEDURES. (Continued) This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management's report in this annual report. (ii) Changes in Internal Control Over Financial Reporting. During the most recent period covered by this report, there has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. ITEM 9B. OTHER INFORMATION. None. PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE. The registrant is a limited liability company and has no officers, directors, or direct employees. The Managing Members manage and control the Company's affairs and have general responsibility and the ultimate authority in all matters affecting the Company's business. The Managing Members are AEI Fund Management XXI, Inc. (AFM), the Managing Member, and Robert P. Johnson, Chief Executive Officer, President and sole director of AFM, the Special Managing Member. AFM is a wholly owned subsidiary of AEI Capital Corporation of which Mr. Johnson is the majority shareholder. AFM has only one senior financial executive, its Chief Financial Officer. The Chief Financial Officer reports directly to Mr. Johnson and is accountable for his actions to Mr. Johnson. Although Mr. Johnson and AFM require that all of their personnel, including the Chief Financial Officer, engage in honest and ethical conduct, ensure full, fair, accurate, timely, and understandable disclosure, comply with all applicable governmental laws, rules and regulations, and report to Mr. Johnson any deviation from these principles, because the organization is composed of only approximately 35 individuals, because the management of a company by an entity that has different interests in distributions and income than investors involves numerous conflicts of interest that must be resolved on a daily basis, and because the ultimate decision maker in all instances is Mr. Johnson, AFM has not adopted a formal code of conduct. Instead, the materials pursuant to which investors purchase Units disclose these conflicts of interest in detail and Mr. Johnson, as the CEO and sole director of AFM, resolves conflicts to the best of his ability, consistent with his fiduciary obligations to AFM and the fiduciary obligations of AFM to the Company. The director and officers of AFM are as follows: ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE. (Continued) Robert P. Johnson, age 64, is Chief Executive Officer, President and sole director and has held these positions since the formation of AFM in August 1994, and has been elected to continue in these positions until December 2009. From 1970 to the present, he has been employed exclusively in the investment industry, specializing in limited partnership investments. In that capacity, he has been involved in the development, analysis, marketing and management of public and private investment programs investing in net lease properties as well as public and private investment programs investing in energy development. Since 1971, Mr. Johnson has been the president, a director and a registered principal of AEI Securities, Inc., which is registered with the SEC as a securities broker-dealer, is a member of the Financial Industry Regulatory Authority (FINRA) and is a member of the Security Investors Protection Corporation (SIPC). Mr. Johnson has been president, a director and the principal shareholder of AEI Fund Management, Inc., a real estate management company founded by him, since 1978. Mr. Johnson is currently a general partner or principal of the general partner in ten limited partnerships and a managing member in five LLCs. Patrick W. Keene, age 49, is Chief Financial Officer, Treasurer and Secretary and has held these positions since January 22, 2003 and has been elected to continue in these positions until December 2009. Mr. Keene has been employed by AEI Fund Management, Inc. and affiliated entities since 1986. Prior to being elected to the positions above, he was Controller of the various entities. From 1982 to 1986, Mr. Keene was with KPMG Peat Marwick Certified Public Accountants, first as an auditor and later as a tax manager. Mr. Keene is responsible for all accounting functions of AFM and the registrant. Since Mr. Johnson serves as the Special Managing Member of the Company, as well as the sole director of AFM, all of the duties that might be assigned to an audit committee are assigned to Mr. Johnson. Mr. Johnson is not an audit committee financial expert, as defined. As an officer and majority owner, through a parent company, of AFM, and as the Special Managing Member, Mr. Johnson is not a "disinterested director" and may be subject to a number of conflicts of interests in his capacity as sole director of AFM. Before the independent auditors are engaged, Mr. Johnson, as the sole director of AFM, approves all audit-related fees, and all permissible nonaudit fees, for services of our auditors. Section 16(a) Beneficial Ownership Reporting Compliance Under federal securities laws, the directors and officers of the Managing Member of the Company, and any beneficial owner of more than 10% of a class of equity securities of the Company, are required to report their ownership of the Company's equity securities and any changes in such ownership to the Securities and Exchange Commission (the "Commission"). Specific due dates for these reports have been established by the Commission, and the Company is required to disclose in this Annual Report on 10-K any delinquent filing of such reports and any failure to file such reports during the fiscal year ended December 31, 2008. Based upon information provided by officers and directors of the Managing Member, all officers, directors and 10% owners filed all reports on a timely basis in the 2008 fiscal year. ITEM 11. EXECUTIVE COMPENSATION. The Managing Member and affiliates are reimbursed at cost for all services performed on behalf of the registrant and for all third party expenses paid on behalf of the registrant. The cost for services performed on behalf of the registrant will be actual time spent performing such services plus an overhead burden. These services include organizing the registrant and arranging for the offer and sale of Units, reviewing properties for acquisition and rendering administrative, property management and property sales services. The amount and nature of such payments are detailed in Item 13 of this annual report on Form 10- K. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. The following table sets forth information pertaining to the ownership of the Units by each person known by the Company to beneficially own 5% or more of the Units, by each Managing Member, and by each officer or director of the Managing Member as of February 28, 2009: Name and Address Number of Percent of Beneficial Owner Units Held of Class AEI Fund Management XXI, Inc. 0 0% Robert P. Johnson 0 0% Patrick W. Keene 0 0% Address for all: 1300 Wells Fargo Place 30 East 7th Street, St. Paul, Minnesota 55101 The Managing Members know of no holders of more than 5% of the outstanding Units. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. The registrant, AFM and its affiliates have common management and utilize the same facilities. As a result, certain administrative expenses are allocated among these related entities. All of such activities and any other transactions involving the affiliates of the Managing Member of the registrant are governed by, and are conducted in conformity with, the limitations set forth in the Operating Agreement of the registrant. Reference is made to Note 3 of the Financial Statements, as presented, and is incorporated herein by reference, for details of related party transactions for the years ended December 31, 2008 and 2007. Neither the registrant, nor the Managing Member of the registrant, has a board of directors consisting of any members who are "independent." The sole director of the Managing Member, Robert P. Johnson, is also the Special Managing Member of the registrant, and is the Chief Executive Officer, and indirectly the principal owner, of the Managing Member. Accordingly, there is no disinterested board, or other functioning body, that reviews related party transactions, or the transactions between the registrant and the Managing Members, except as performed in connection with the audit of its financial statements. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. (Continued) The limitations included in the Operating Agreement require that the cumulative reimbursements to the Managing Members and their affiliates for certain expenses will not exceed an amount equal to the sum of (i) 20% of capital contributions, (ii) 1% of gross revenues, plus an initial leasing fee of 3% of gross revenues for the first five years of the original term of each lease, (iii) 3% of Net Proceeds of Sale, and (iv) 10% of Net Cash Flow less the Net Cash Flow actually distributed to the Managing Members. The cumulative reimbursements subject to this limitation are reimbursements for (i) organization and offering expenses, including commissions and an Organization Fee, (ii) acquisition expenses paid with proceeds from the initial offering of Units, (iii) services provided in the sales effort of properties, and (iv) expenses of controlling persons and overhead expenses directly attributable to the forgoing services or attributable to administrative services. As of December 31, 2008, these cumulative reimbursements to the Managing Members and their affiliates did not exceed the limitation amount. The following table sets forth the forms of compensation, distributions and cost reimbursements paid by the registrant to the Managing Members or their Affiliates in connection with the operation of the Fund and its properties for the period from inception through December 31, 2008. Person or Entity Amount Incurred From Receiving Form and Method Inception (March 14, 2005) Compensation of Compensation To December 31, 2008 AEI Securities, Inc. Selling Commissions equal to 10% $1,790,447 of proceeds, excluding proceeds from distribution reinvestments, most of which were reallowed to Participating Dealers. Managing Members Reimbursement at Cost for other $ 916,368 and Affiliates Organization and Offering Costs. Managing Members Reimbursement at Cost for all $ 278,726 and Affiliates Acquisition Expenses. Managing Members Reimbursement at Cost for all $ 353,465 and Affiliates Administrative Expenses attributable to the Fund, including all expenses related to management of the Fund's properties and all other transfer agency, reporting, Member relations and other administrative functions. Managing Members Reimbursement at Cost for all expenses $ 0 and Affiliates related to the disposition of the Fund's properties. Managing Members 3% of Net Cash Flow in any fiscal year. $ 55,970 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. (Continued) Person or Entity Amount Incurred From Receiving Form and Method Inception (March 14, 2005) Compensation of Compensation To December 31, 2008 Managing Members 1% of distributions of Net Proceeds $ 0 of Sale until Limited Members have received an amount equal to (a) their Adjusted Capital Contributions, plus (b) an amount equal to 6.5% of their Adjusted Capital Contributions per annum, cumulative but not compounded, to the extent not previously distributed. 10% of distributions of Net Proceeds of Sale thereafter. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES. The following is a summary of the fees billed to the Company by Boulay, Heutmaker, Zibell & Co. P.L.L.P. for professional services rendered for the years ended December 31, 2008 and 2007: Fee Category 2008 2007 Audit Fees $ 15,000 $ 16,400 Audit-Related Fees 0 0 Tax Fees 0 0 All Other Fees 0 0 --------- -------- Total Fees $ 15,000 $ 16,400 ========= ======== Audit Fees - Consists of fees billed for professional services rendered for the audit of the Company's annual financial statements and review of the interim financial statements included in quarterly reports, and services that are normally provided by Boulay, Heutmaker, Zibell & Co. P.L.L.P. in connection with statutory and regulatory filings or engagements. Audit-Related Fees - Consists of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of financial statements and are not reported under "Audit Fees." These services include consultations concerning financial accounting and reporting standards. Tax Fees - Consists of fees billed for professional services for federal and state tax compliance, tax advice and tax planning. All Other Fees - Consists of fees for products and services other than the services reported above. Policy for Preapproval of Audit and Permissible Non-Audit Services of Independent Auditors Before the Independent Auditors are engaged by the Company to render audit or non-audit services, the engagement is approved by Mr. Johnson acting as the Company's audit committee. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES. (a) (1) A list of the financial statements contained herein is set forth on page 12. (a) (2) Schedules are omitted because of the absence of conditions under which they are required or because the required information is presented in the financial statements or related notes. (a) (3) The Exhibits filed in response to Item 601 of Regulation S-K are listed below. 3.1 Certificate of Limited Liability Company (incorporated by reference to Exhibit 3.1 of the registrant's Registration Statement on Form SB-2 filed on May 26, 2005 [File No. 333- 125266]). 3.2 Operating Agreement to the Prospectus (incorporated by reference to Exhibit A of the registrant's Registration Statement on Form SB-2 filed on October 14, 2005 [File No. 333-125266]). 10.1 Assignment and Assumption of Lease and Guaranty dated April 3, 2006 between the Company and AEI Fund Management XVII, Inc. relating to the Property at 6959 East 21st Street, Wichita, Kansas (incorporated by reference to Exhibit 10.1 of Form 8-K filed April 5, 2006). 10.2 Assignment and Assumption of Lease dated May 31, 2006 between the Company, AEI Income & Growth Fund 24 LLC and Blue Bell Partners, LLC relating to the Property at 65 North University Boulevard, Middletown, Ohio (incorporated by reference to Exhibit 10.2 of Form 8-K filed June 7, 2006). 10.3 Net Lease Agreement dated September 21, 2006 between the Company, AEI Fund Management XVII, Inc. and Apple Indiana II LLC relating to the Property at 7345 E. Washington Street, Indianapolis, Indiana (incorporated by reference to Exhibit 10.2 of Form 8-K filed September 26, 2006). 10.4 Assignment and Assumption of Lease dated December 29, 2006 between the Company, AEI Income & Growth Fund XXII Limited Partnership and AEI Fund Management XVII, Inc. relating to the Property at 1516 South Washington Street, Crawfordsville, Indiana (incorporated by reference to Exhibit 10.1 of Form 8-K filed January 8, 2007). 31.1 Certification of Chief Executive Officer of Managing Member pursuant to Rule 15d-14(a)(17 CFR 240.15d-14(a)) and Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer of Managing Member pursuant to Rule 15d-14(a)(17 CFR 240.15d-14(a)) and Section 302 of the Sarbanes-Oxley Act of 2002. 32 Certification of Chief Executive Officer and Chief Financial Officer of Managing Member pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AEI INCOME & GROWTH FUND 26 Limited Liability Company By: AEI Fund Management XXI, Inc. Its Managing Member March 26, 2009 By: /s/ Robert P Johnson Robert P. Johnson, President and Director (Principal Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Name Title Date /s/Robert P Johnson President (Principal Executive Officer) March 26, 2009 Robert P.Johnson and Sole Director of Managing Member /s/Patrick W Keene Chief Financial Officer and Treasurer March 26, 2009 Patrick W. Keene (Principal Accounting Officer)