San Francisco, CA · Member since 2017 · 3 posts · 0 votes
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.
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.
@Brian Burke what if the LPs were bought out at the time of the refi? Would that share of tax due then fall on the GPs when they sold in a later year and the LPs would not owe any tax on that 50k?
If you purchase their positions from them any gain from that sale would be taxable. A simple refinance wouldn’t “buy them out” any more than you’d be bought out of your own home if you did a cash out refinance. Returning capital to investors doesn’t change their ownership interests. The only way they get bought out is if they sell their ownership interests to you or someone else. The gain from such a sale would be treated the same as the gain from an arms-length sale of the real estate to a third party.
The plan would be to return their initial investment with the refinance proceeds. Wouldnt this return their unrecovered capital contribution which would lower their basis? If its strictly a return of initial capital wouldnt that not be taxable? And if we return all their investment they would be left with zero interest so any additional distribution given to the LPs beyond this point from the refi would not be taxable but the GPs would deal with the tax implications upon sale in a later year.