Ways to Unequally Split Profits?

[Sean Imfeld]

So here's the deal: My mother (the money) and I would like to buy some properties together, with any rent profits distributed unequally to us both (let's say 90/10 in favor of my mother), with the understanding that this will change to more of a 50/50 split in a few years. I know LLCs may not be very necessary or useful when first starting out, but is there any other way to split profits unequally like we want? Can we just split them up ourselves without an LLC, or would that create tax issues? All discussions I've managed to find have focused on even profit splits.

Any help would be much appreciated.

[Bill Gulley]

You can split profits any way you want to, just keep books on who gets what for taxes to carry over to your 1040 return. It's mom, shouldn't have an issue. Good luck :)

[Sean Imfeld]

Great.  Thanks!

[Kevin Bellavance]

@Sean Imfeld

Hi Sean,

I see two ways here :

Partnership (Joint ventures) :

This agreement should document how future business decisions will be made, including how the partners will divide profits, resolve disputes, change ownership (bring in new partners or buy out current partners) and how to dissolve the partnership.

Coporation :

With this one, it is very easy to ''split 90/10'' because it is based off Shares. However, it is a more complex business structure with higher ''set up fees''. But to show you how easy it is once it's set up, here's an example :
When you create the corporation (using a lawyer is highly recommended), you decide that your mother holds 9000 shares and you hold 1000 shares. There is a total of 10 000 shares and they are worth 1$ each (price is arbitrarily). What does this means? It means that if you buy 2 properties and the Corporation is now worth 60 000$, you have a position worth  6000$. Let's say the company generates a net income of 10 000$ yearly and you distribute 100% of that income in dividends, then you get 1000$ in dividend and your mother gets 9000$ which is a 1$ dividend/shares.

What's great with it is that if in 2 years you bring 50K of your own money to the table and by that time the company's shares are worth 2$ (due to growth of your portfolio), this is what happens.

Initial 10 000 shares are now worth 2$, for a market cap of 20 000$.

You bring 50K and it buys you 25 000 shares at 2$. There is now a total of 35 000 shares. You hold 26 000 shares (1000 + 25 000) and your mother 9000 shares. You are now majority owner of the company with a 74% position.

Take notes that the market cap (shares value x number of shares) doesn't equal the company's value. Company's value is based off income, profitability, debt and many more components. 

Hope this helped you with your short and long term goals.

Kevin

[Daniel Chang]

You can split profits any way you want.  As long as there's a valid reason to do so and the goal is not for decreasing of tax payments.  In your case, since your mom is fronting most of the initial capital, then there's very valid reason why she gets 90 to your 10.  It however becomes an issue if the following year, your mom wins the lottery putting her at the maximal tax bracket, and you change the split to 90% in your favor in order to minimize the taxes (for instance).  

I agree to have an agreement that documents the contribution and the split, and to adhere to this.  If there is going to change in split in the future, document down what is expected, and what it takes to achieve the change.  If you are 90/10 for 5 years, and all of a sudden change to 50/50 without a valid reason, the IRS may question if they audit.  

What you may have to watch out for is that if you don't put down any capital, your 10% split may be categorized as self employment income, which would be subject to self employment taxes.  In essence, your 10% split comes from your "sweat equity".  While the rules behind this is murky, this is where I would consult a tax professional.