Client partnership unraveling

[Julius V.]

Working with a client whose 3-way rental property partnership (bought with friends) is falling apart. The property is held in an LLC taxed as a partnership...one partner wants out, another wants to refi and buy them out...no formal operating agreement, just a handshake and some rough P&L splits over the years.

I've been working on deliverables to show the potential gain recognition if one partner cashes out and how to allocate basis correctly across the remaining partners. Might also be a good time to restructure the entity since they've alluded to wanting to scale into STRs and take advantage of 100% bonus depreciation.

Pretty emotional time for my client. Would love to hear from anyone who's worked through a partner exit. What worked well? What would you do differently?

[Stuart Udis]

Working with a client whose 3-way rental property partnership (bought with friends) is falling apart. The property is held in an LLC taxed as a partnership...one partner wants out, another wants to refi and buy them out...no formal operating agreement, just a handshake and some rough P&L splits over the years.

From this I can make a few assumptions but also have some follow up questions:

1. You mention your client is one of the three partners. What's your client's objective?  You mention one partner wants to be bought out and the other wants to use refinance proceeds to acquire the membership interest.

 2. I am making an assumption that there is a loan on the property since you mention the possibility of a refinance generate the proceeds to generate the required proceeds to buy out the partner.  If that's the case, who is the guarantor? One Partner? Two partners? All three?  

3. Are you only hearing the story through your client or are you in communication with all three partners? I ask because you say there is no operating agreement but if there's a loan on the property I am fairly certain there is. This is something the lender would have required. It may not be a good OA, but it will likely cover at minimum voting rights. It's one thing most lenders will examine. Even without a loan I doubt a bank is opening a bank account in the LLC name without an OA. Title companies generally request this as well, particularly when the buyer is multi-member. Now for the follow up.... Is there no operating agreement or is it merely silent on terms that are favorable to your client? That's what I would ask if I were you.

4. What is the collateral? Is there sufficient equity to buy out one partner through a refinance? Do the remaining partners have the signatures necessary to obtain the financing?

I would start here. Answers to each of these questions are necessary before any decision can be made.