Private money for flip

6 Replies

Hi all, 

I just upgraded to PRO today! Taking my first step towards REI and flipping. After researching, I cannot find the exact answers I need to for my questions, hoping you all can help! I think I found my first house to flip and need to make moves fast. I will be using a private money lender - my father in-law. He will be loaning money from a Merrill Lynch account (I believe it is an IRA).

Questions:

1. How do I get the money LEGALLY? Meaning following all the rules re: tax implications, etc. Does he just wire the money to my account?

2. How does IRS tell the difference between a loan and gift money?

3. If he funds the purchase and repairs, I will do all the work (meaning some demo, finding/scheduling/managing contractors & projects, etc) we will spit the proceeds. Is this a fair arrangement?

4. Do I need an accountant or a lawyer?

5. Are there any other questions I am not asking that I should be????

Hi @Shannon Moyer ,

I hope these answers help!

1. Since the money is coming out from an IRA, he should check with Merrill Lynch on the tax implications. The amount he can withdraw will depend on the type of IRA and his age (maybe other factors too). Merrill Lynch can probably also advice as to the easiest way to transfer the money. Perhaps he can just write a check?

2. The IRS will just look at your returns, so you'll just want to make sure you get the reporting right. You may look into hiring a CPA to prepare your returns.

3. Yes, splitting the proceeds is a good way to do it. In that case, your father-in-law is no loaning the money... you'd probably just consider him an equity investor. A loan comes with an interest rate and is paid before the equity holders get paid.

4. You probably don't need a lawyer on a small deal like this, provided you have a good, trusting relationship with your father-in-law and you don't want to do this through a business entity (like an LLC). You also don't "need" an accountant as the bookkeeping and as tax preparation for a single deal are not super difficult. However, if you want to focus on doing the work for this first deal, outsource the accounting would not be a bad idea (see #2).

5. You're asking good questions! Keep reading and learning.

I hope that helps. I wish you the best!

@Jonathan Towell , thanks for the reply!! 

In this case, would this be considered a cash offer? I would NOT need to check of any mortgage/loan contingencies on the contract, correct? I would deposit the money from him into my account prior to signing the contract, pay the "good faith deposit" and the total due at closing with a cashiers check directly from my account. This make sense, right?

Instead of splitting the proceeds 50/50, could we have an arrangement that is an actual loan with an interest rate but due in one lump sum after we sell the flip? I am concerned about not having the money to pay for the interest payment on a monthly basis while rehabbing. 

Thanks in advance - this is really helpful!!! 

Yes, to the seller, you are bringing a cash offer. It is considered a cash offer because you've already got the loan approved and the money is ready to fund. So, you don't need to check any loan contingencies. However, that doesn't mean you shouldn't have an inspection contingency. If, however, you are buying it with cash and without an inspection, you could tell the seller that you can close in a few days, which might let you negotiate for a lower purchase price.

In the scenario where there is a loan with interest, and the interest is all your father-in-law receives (he isn't getting any of the profit after the sale), then he is indeed a true lender and this is a true loan/mortgage. You'll record the interest as an expense and the principal as a liability (see a CPA or bookkeeper for more details).

If you are concerned about making interest payments during the flip, you can modify the terms of the loan with your father-in-law to accommodate. For example, the loan could have no payments due in the first 12 months. However, interest is still accruing. This way, your father-in-law still makes some money, he just won't see the first payment for 12 months.

1. How do I get the money LEGALLY? Meaning following all the rules re: tax implications, etc. Does he just wire the money to my account?

It appears that he will need to take the money out of the account to provide you the balance in the IRA. If he is not 59 1/2 - I would likely advise him not to take the money out since he may be subject to a 10% penalty. 
Also - just to clarify - I don't think the IRA account allows you to loan against it to take the money out. It is likely a distribution.
Self-directed IRA's are allowed to make make business loans to generate interest income. However, I am not 100% if a father-in-law is a disqualified person.

2. How does IRS tell the difference between a loan and gift money?

Gift is property given without the requirement for it to be paid back.
One can be gifted $15,000 in cash without the requirement of a gift-tax return.
Gifts in excess of $15,000 require a gift tax return.

Loans is property given with the requirement for it to be paid back.
Loans require interest to be paid along with the principal.
The IRS may put an imputed interest if there is no interest in the loan.

3. If he funds the purchase and repairs, I will do all the work (meaning some demo, finding/scheduling/managing contractors & projects, etc) we will spit the proceeds. Is this a fair arrangement?

You and your father-in-law can agree to whatever split in profit/loss percentage. It is better to have it in writing. 

4. Do I need an accountant or a lawyer?

Your state may require you to have a lawyer at closing. Please check with your state's laws.
Regardless if you are not required to - you may want him to draft or review the agreement you get with your father in law.
You are not required to have an accountant but it is recommended(slightly biased!).

5. Are there any other questions I am not asking that I should be????

It seems like you have everything covered.

@Shannon Moyer hi, Shannon, I am a lender from Reading PA and will try to answer your questions. I think first of all you have to make sure what structure you are working out with your in-law. If you regard him as a PML, then you pay him interest (at a rate both you agree upon), and he doesn’t split any profits. You may want to make sure you have all loan documents (mortgage, promissory note) drafted. If you partner with him, i.e., he put money and you put your time, effort and knowledge to manage the rehab, then you work out a % of split profits between you two. Either way, he had to makes sure with Merrill Lynch that he is qualified for the money he is withdrawing without penalty. For tax return purposes, if you pay him interest, he needs report as interest income on his tax return. Thanks.

If the private lender participates in part of the profit, are they subject to higher taxes (such as personal income tax) as opposed to lending at a set interest rate?