Cash out refinance distribution to investors (tax implications)

[Scott Johnston]

We are looking at building a model where we refinance to pull cash out and return capital to LPs. Typically cash out from a refinance is not taxable but does it become taxable if excess is given to LPs beyond their initial investment? 

Simple Example - LPs invest 100K. Refinance pulls out 150K and given all to LPs. Will the additional 50K be taxable? Do the tax implications change if LPs still maintain some ownership after receiving the 150K vs being bought out with no remaining ownership? I imagine GPs will be effected at the time of sale at a later date when determining basis etc.

Thanks

[Brian Burke]

It is taxable, just not when the distribution is made.

Using your example, if all LPs invested $100K and you've refinanced the property with a loan amount high enough to return $150K, you were only able to obtain a loan large enough to do that because the property went up in value.

So you distribute the $150K.  No tax is due.  Then let's say a year later you sell the property, and after all costs of sale, etc, there is no money to distribute.  Your LPs will owe tax on their $50K gain, even though they have been distributed nothing at the time of the sale. Or, let's say that at the time of sale there is an additional $50K to distribute.  Your LPs will owe tax on $100K of gain even though they were only distributed $50K at the time of sale.  

For simplification, these examples are ignoring the effect of depreciation and recapture.