Using a friends money - taxes and LLC thoughts?

9 Replies

Looking to use a friend's money who is interested in investing to buy rentals and flips.

Two questions:

1) can I borrow money from him, like an unofficial hard money lender, without us being in an LLC together? He would get a % return, but would he still have tax benefits? How do we track the money in and out?

2) Similarly, if I have an LLC and he has an LLC can we go in on a property together? Would we have to form a new LLC or a partnership with our LLCs together?

Basically having trouble figuring out how to track money in an out.

Thanks for the help.


@Jeremy Tillotson is right. Figure out what you want to do and set it up. If he only wants to be an outside lender, he loans to you, you pay him interest, done. If you think you want more, or he wants equity and depreciation or something, then make an LLC together that spells out ALL YOUR RESPONSIBILITIES and move forward that way.

Define what you want. Almost anything is possible.

To answer your questions:

1. can I borrow money from him, like an unofficial hard money lender, without us being in an LLC together? He would get a % return, but would he still have tax benefits? How do we track the money in and out?

Yes.  You do not have to be joined in an company to borrower money from him. 
His return would be the rate of interest on the note less servicing fees.  
He would not be a property owner so he has no tax benefits.  The interest payments are reported as income when he files his taxes.  Whatever tax breaks he can find inside his company and around his personal filings are where he might see breaks.  He doesn't have any tax break as a direct result of the subject property of the loan.  That is only for the owner of the real property.

Tracking the money makes it sound like what you are concerned about are the draw downs of capital for repairs.  So the loan would have an initial funding of $X and the lender agreed to also give money for repairs, perhaps delivered in segments to manage the process.  Those are called "draws".  There are companies that will manage draw down requests.  Usually an property inspection occurs and if the progress is approved the next set of funds is released.  He should board his loan with a servicer and the servicer will handle the periodic payments and the balance increases from draws.  Outside of that, typically the money lent is simple math.  Do not nickle and dime the draws, that would make it confusing and tedious.  The draws should be large enough to get a fair amount of work done.  You can have several draws with typical draw schedules being around 3 or 4. The lender sets the draw schedule in relation to the work milestones.  Everyone then agrees to it.  

2.  Similarly, if I have an LLC and he has an LLC can we go in on a property together? Would we have to form a new LLC or a partnership with our LLCs together?

You having an LLC simply changes who you vest as the owner on title.  Instead of you personally, you use your LLC.  

Can you both title the property together?  Yes. You can do Joint Tenants or Tenants In Common.  @Bill Gulley has an article/blog out there that talks about what a TIC is and how it works.

You do not have to file a new company which the two of you join either as natural persons or as companies.  That is probably not what you guys want to do right now.  It is likely a better tactic to simply have you title the property in your or your company name and have him simply hold a mortgage/deed of trust and note for the money.  This avoids having to sort out all sorts of responsibilities inside a joined LLC.  Those responsibilities are defined in the Operating Agreement of the company.  

Thanks, @Jeremy Tillotson , @brianotteson, and @diondepaoli

This is all really helpful. One avenue were trying to accomplish is cash foreclosure through county auctions. If I do all the work and he fronts the cash, how we set up the agreement/LLC, etc is crucial before we get into one. Does his LLC buy the property and then pay my LLC when we sell? Just trying to think through it since cash auctions go quick and you can't set up LLCs for each property.

This has helped a lot, much appreciated. 

@Mark Poshak why not so a deal and then deiced if you want the expense of an LLC? He might want an llc if he is to hold, but he could just pay you directly then. There are very good reasons to both have an LLC but you haven't mentioned any of them yet, so why have the expense of them (setting up, separate returns, ect). If you continue to do them then talk tax strategy, I see people so worried about tax setup when threes no deal yet. (IE no taxes because no money)

@Mark Poshak

Some details are changing by not being initially exposed. 

So are you contributing capital or just sweat equity?  

Does the other party have enough cash to handle the entire investment?  The initial response to my post mentioned you would put up say $100k but the project may require $800k.  So does that mean the other $700k comes from the only other party here or is there a need to raise money from more investors outside the two of you?

The more investors there are the more things get complicated.

 If we assume it is just the two of you then we can describe a couple of easy options.  First, if the other guy has enough funds to purchase the property in cash then that makes it somewhat simple.  Let him.  His company forks out the purchase price and title vests in the name of his company.  He is protected because he owns the real property.  That leaves us with your role and function.  

If you are contribution cash then you can join him on title and that title can be split to match your contributions.  So you have 12.5% of the property and he has 87.5% of the property.  Proceeds from sale or cash flow would simply follow that percentage based ownership.  Title would be held in Tenants In Common which makes both of you owners and thus removes possibilities of license violations.  If you do not own the property you can't market it or lease it or sell it, he has to unless you are a licensed real estate agent.  As an owner, it is yours too so license mandates are relieved.  

In the TIC each of you would title the property to each of your prospective companies. You will have to work out the evidence of capital deployment outside of purchase. In other words, if he pays for the property and you pay for repairs he would want to reconcile your contribution to ensure that you deployed $100k into the property's rehab which gave you the pro rata share of title.

The purchase can be made and you join title after or you can join simultaneously.  That is up to you guys.

In that type of structure you both enjoy the upside from the property.  What ever it sells for and nets down to is distributed.  Neither investor is a debt investor, you both are equity investors.  Whether you make the return target is determined by the net proceeds.  Fairly simple and straight forward.  

Another alternative is you guys join your two companies inside another vehicle, like an LLC or LP, each contributing the set amount of cash into the company and the company makes the investment, title vests in that name and control of the company is determined by the Operating Agreement. Since this investment is one of equity the return floats with the proceeds from the property in a pro rata form based on the initial capital injection from each investor. This would require setting the company up before making the purchase at auction.

An alternate structure is the other guy comes in as a debt investor. This would mean the property is vested in the name of your company and the other investor takes back a mortgage or deed of trust on the property to secure his money given to you to make the purchase. In that setting the investor is only entitled to the rate of interest on the note. Fairly straight forward again. 

The other guy would not want you to hold title as Joint Tenants because that would mean you gain in equity as JT means 50/50.  He would be diminished in comparison to his capital contribution.

There are some other more complex structures but one of those three would work if there is only two of you.  I would venture to say keep the first one or couple transactions as simple as possible for you try and complicate the party.

@Dion DePaoli Thanks for the details. This is what I was looking for - Tenant in Common. We have all sorts of scenarios that could play out, but most likely he will front all cash for the property and I will provide sweat equity and maybe repair costs. So this will work well. Thanks.