Calculating My Buyout as Partner

6 Replies

I've lurked around here quite often for good while now. It's time for an actual post.

A partner and I own a fourplex together 50/50 and I'm thinking that I'd like to cash out and go on my own now that I would have the capital to do so. I'll list what he has proposed as a calculation of the buyout amount. He has calculated this based on if we were to put it on the market right now and split everything 50/50. My question is if all of these expenses should be in the calculation - I don't know if the bank fees and Capital Gains are supposed to be factors in this or not...

Property Value: about $220k (to be appraised)
Current Mortgage amount remaining: $105,500

Would be Bank Fees: $4000 (early termination on fixed rate)
Legal: approx $1600
Real Estate fees: 4.5% from final sale (about $9900)

Projected gross profit of sale: $99,000

He is saying that Capital Gains must be taken off which a mutual acquaintance of ours who is an accountant has stated would be 26%. However I've found this accountant to have given quite inaccurate information more often than not. But say we go with that...

26% of taxable profit (50%): $12,870

Total Net Profit for each partner AKA my buyout amount: $43,065


Even at this amount I'm fairly happy with how we've done - coming out with 43k from a 16k investment 3 years ago. 
However my issue is with the Capital Gains being in there...Is that normal? I believe Capital Gains is also marginal, so it changes depending on the tax bracket you're in. Looking at the 2014 Capital Gains rates for Ontario Canada (http://www.taxtips.ca/taxrates/on.htm) for my income level, my CG's rate should be more like 16.49% - not 26%. 
Additionally, wouldn't this mean that when it actually comes time to do my taxes next year, I'll report this profit, and actually pay capital gains again - this time on 50% of my $43,065???

My apologies for the long winded explanation here but I'm hoping any major flaws in this can be pointed out.
I thank you for your time and expertise in advance!

I don't understand the Capital gains being taken out of your equity deal.  Get a second or 3rd opinion.  The property is not being sold, you are cashing out your equitable interest.  In a refinance at least here in the US you don't pay Capital Gains.  Its only on the sale.   You are not selling your property, you are cashing out your interest.   

Get another opinion.  You can structure this in a way that is benefitial to you both.  

I'm sorry.   That's if you choose to refinance.   

You need your own CPA.  If you are reporting the property correctly right now you should not give him capital gains tax to make up for his future tax burden.a

1.  Your partnership agreement should be the documents that tells you how this should haoppen.

2.  If your partnership agreement is silent, your state's business laws will be the default.

3.  If you are just negotiating an amicable split, anything you agree on goes.  I assume this is what you are doing, so anything goes.

Some issues, quations I see are:

1.  How is the property titled and mortgaged?  Is he refinancing out of both of your names into his?  This must be where the bank fees are coming in.

2. The reson he wants to reduce your proceeds by a capital gains tax rate is because when he refinances the property out of your name his CPA is thinking this is not a taxable event (it is not) and thus his tax basis would stay the same.  He woudl then get the hit for the entire gain when he sells the property because his basis remained the same.  This is wrong.  The way to handle this for tax purposes is buyout is a sale of half the property from him to you.  A good (I mean any decent) CPS should know this.  You pay your own taxes on the half of the property you sell him based on your current basis, and his basis will increase by the amount he pays you so when he sells, the portion youpaid taxes on is already accounted for.  All the fees and stuff are just negotiated into the selling price of your half of the property. 

Get a new CPA.  It will be treated for tax purposes as you both have always owned half the property and you are selling him your half.  Plain and simple. 

Originally posted by @Nathan K.:

A partner and I own a fourplex together 50/50 and I'm thinking that I'd like to cash out and go on my own now that I would have the capital to do so. I'll list what he has proposed as a calculation of the buyout amount. He has calculated this based on if we were to put it on the market right now and split everything 50/50. My question is if all of these expenses should be in the calculation - I don't know if the bank fees and Capital Gains are supposed to be factors in this or not...

Ahh partners, they are great ... until they are not.  When you started this partnership, did you draft a written agreement with buyout terms (shotgun clause, etc)?


Property Value: about $220k (to be appraised)

Current Mortgage amount remaining: $105,500

Would be Bank Fees: $4000 (early termination on fixed rate)

Legal: approx $1600

Real Estate fees: 4.5% from final sale (about $9900)

Projected gross profit of sale: $99,000

Are you putting the property up for sale, or simply pulling the trigger on your agreement and he is buying you out?

If it is the former, then the partnership/company will discharge the mortgage (including any penalties) and pay all the costs of sale from the proceeds.   The net amount will be distributed as per the partnership and you will both be responsible for your own taxes (capital gains will be due on your portion if you realized a gain on the disposition of the property and you have no other losses to offset the gain).  If the property is held in a company, then the company realizes the gain and pays the taxes.  You and/or your partner would only realize a taxable event if you withdrew the retained earnings from the company (either as a dividend or via a share repurchase).

If it is the latter case and your partner is buying you out, then you simply agree on a price for your 50% of the property.  Your portion of the mortgage would be assumed by your partner and would be deducted from the paid out proceeds.  There would be no realtor fees as a realtor is not required.  There may be legal and accounting fees to draw-up the purchase and release.  If you are both guarantors or borrowers on the mortgage, then the mortgage will most probably need to be discharged and your partner will place a new mortgage on his own.  In this case there would be early discharge penalties due and it would not be unreasonable for your partner to expect you to shoulder these fees since you are forcing the situation.   Your partner may also insist you pay the legal and accounting costs associated with your exist.   All this would be negotiable, unless laid out in your partnership or shareholders agreement.


He is saying that Capital Gains must be taken off which a mutual acquaintance of ours who is an accountant has stated would be 26%. However I've found this accountant to have given quite inaccurate information more often than not. But say we go with that...

26% of taxable profit (50%): $12,870

Total Net Profit for each partner AKA my buyout amount: $43,065

If you realize a gain on your sale to your partner - or on your portion of the sale of the property to a third-party - any taxes due are between you and the CRA and have nothing to do with your partner who should not be deducting them from your proceeds ... you're a big boy, he need not remit your taxes for you .... besides, if he deducts the amount and does not remit it, the CRA will come to you with their hand out next April and you will pay twice.

Even at this amount I'm fairly happy with how we've done - coming out with 43k from a 16k investment 3 years ago. 

However my issue is with the Capital Gains being in there...Is that normal? I believe Capital Gains is also marginal, so it changes depending on the tax bracket you're in. Looking at the 2014 Capital Gains rates for Ontario Canada (http://www.taxtips.ca/taxrates/on.htm) for my income level, my CG's rate should be more like 16.49% - not 26%. 

Additionally, wouldn't this mean that when it actually comes time to do my taxes next year, I'll report this profit, and actually pay capital gains again - this time on 50% of my $43,065???

You are correct, the resulting included capital gain on your realized gain from the sale of your portion of the property (offset by any other capital losses) would be included at your marginal tax rate.   As per my note above, this is between you and the taxman and does not involve your {soon to be ex-}partner.

 

Here is another way to look at it, would you pay 46k for the other half of this building?  How much cash-flow would you get for that additional investment, and what would be the return on it?

If it is a good deal then turn the offer around.  What if you paid he the 46k and sold it the next day, how would the numbers look for you then?

Many thanks to you all for your knowledge and insight on this. It is very much appreciated!

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