Tax Implications for Refinancing a Property in an LLC and Distributing Funds

Investor · Member since 2019 · 8 posts · 4 votes

Hey All- I own a small apartment complex in a two entity LLC and am wondering what the tax implications are for a cash out refinance. I have done a lot of these for my own portfolio, but am wondering if the tax implications are different if we do a cash out refinance for this partnership LLC and then have to "distribute" the funds to the members. Both of the members of the LLC we are hoping to do the cash out refinance for are also LLCs if that matters, so it would be distributed from one LLC to another LLC to hopefully the members pockets.

Want to make sure that the money remains tax free the whole way and we don't have any surprises. Thanks for any advice you can give!

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Randall Tannen

CPA | Accepting New Clients · Member since 2022 · 62 posts · 36 votes

@Georgeos Partheniou basis limitations and DFDs are two separate topics. The interest tracing rules come into play for debt financed distributions. The deductibility of any interest connected with distributed debt proceeds has to be traced to what the funds were used for. It can potentially be deductible as an ordinary or rental expense, an itemized deduction or simply non-deductible.

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Ashish AcharyaBusiness Member
CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
3y
Most likely, there will be no taxes. Makes you are tacking your outside basis to be sure.
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Randy Rodenhouse
Investor · Charleston, SC · Member since 2011 · 606 posts · 413 votes
3y
Just wanted to mention that the cash out refinance funds are not tax free forever. It is tax free in the sense that you will not owe taxes today on the cash-out. However, your investment in the house, officially called tax basis, did not go up. You have a bigger loan, but not a bigger tax basis. So your capital gain when you sell this property will be calculate against your tax basis and not against your mortgage as many investors expect. In effect, you will end up paying tax on your refi cash later on, when you sell the property.
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Chris Picciurro
Accountant · Franklin, TN · Member since 2023 · 204 posts · 91 votes
3y
In general not taxable, but can be if funds are disbursed past your basis.
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Basit SiddiqiBusiness Member
Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
3y
You may want to research the term ' Debt Financed Distribution' Which does have a tax implication for the investors receiving a distribution.
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Georgeos Partheniou
Member since 2024 · 12 posts · 4 votes
2y
Quote from @Basit Siddiqi:

You may want to research the term ' Debt Financed Distribution' Which does have a tax implication for the investors receiving a distribution.
So essentially the loan is tax free if kept inside the Llc but not if taken into personal name?
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Randall Tannen
CPA | Accepting New Clients · Member since 2022 · 62 posts · 36 votes
2y
@Georgeos Partheniou basis limitations and DFDs are two separate topics. The interest tracing rules come into play for debt financed distributions. The deductibility of any interest connected with distributed debt proceeds has to be traced to what the funds were used for. It can potentially be deductible as an ordinary or rental expense, an itemized deduction or simply non-deductible.
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Georgeos Partheniou
Member since 2024 · 12 posts · 4 votes
2y
Thanks for your reply! I’m New to this forum and have been getting conflicting advise on this matter.
This is a question on refinancing-
If I own a property in a Llc company with lots of equity, I refinance, that money is classed as tax free as it’s a loan/debt? Can I personally take that extra finance money tax free into my own name or personal bank account to do with what I please, or does the refinance money have to stay in that Llc company and I cant use it personally.
Many thanks
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Randall Tannen
CPA | Accepting New Clients · Member since 2022 · 62 posts · 36 votes
2y
If you refi a property in an MMLLC and then distribute the loan funds, there is likely no tax consequence. However, you'll want to verify that through analysis your outside basis in the entity.
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Ahad AliPro Member
CPA/Investor · Bronx, NY · Member since 2018 · 236 posts · 45 votes
2y
Quote from @Angus Brooks:

Hey All- I own a small apartment complex in a two entity LLC and am wondering what the tax implications are for a cash out refinance. I have done a lot of these for my own portfolio, but am wondering if the tax implications are different if we do a cash out refinance for this partnership LLC and then have to "distribute" the funds to the members. Both of the members of the LLC we are hoping to do the cash out refinance for are also LLCs if that matters, so it would be distributed from one LLC to another LLC to hopefully the members pockets.
Want to make sure that the money remains tax free the whole way and we don't have any surprises. Thanks for any advice you can give!
Hi Angus,
A cash-out refinance is typically not considered a taxable event for businesses since the borrowed funds are regarded as liabilities owed to the lender. When filing the LLC return, it is important to ensure that these liabilities are accurately reflected on the balance sheet.
However, it's essential to note that distributing the refinance proceeds among LLC members could potentially be viewed as a taxable event if there is no intent to repay these amounts to the LLC. The tax treatment in such cases may vary depending on specific circumstances. Therefore, it is advisable for the client to consult with their CPA to receive personalized guidance tailored to their unique financial situation.

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John MorganPro Member
Rental Property Investor · Grand Prairie, TX · Member since 2018 · 2k+ posts · 2k+ votes
2y
@Angus Brooks
It’s all tax free. Do what you want with it.
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Kory Reynolds
Accountant · NH · Member since 2019 · 269 posts · 288 votes
2y
Generally there is no immediate tax implication to doing this. There can be specific issues that can cause the distribution to be taxable related to partners having enough basis / debt basis to distribute the proceeds. If one partner unconditionally guarantees the debt, this can sometimes require some side room guarantees to that partner to ensure no one recognizes a capital gain.
As a few others have alluded to, there is a secondary problem known as a "debt financed distribution interest expense." What this stems from is that the IRS requires that a taxpayer trace interest expense to the nature of how the proceeds are used. What does this mean? Say you had a $1m loan. You refi to a $1.5m loan. You distribute $500k to the partners. The partnership is now paying interest expense on a $1.5m loan. Say the partners took this $500k and each bought themselves a personal boat. In a very simplified example, 33.33% of the interest expense on this loan ($500k distributed / $1.5m loan balance) is now attached to the boat(s). Since the boat is personal, that interest expense is personal, and is no longer deductible - for each year and forever more. Say that $500k is invested in a new trade or business - now it is business interest expense. Say it is invested in a stock portfolio - now it is investment interest expense. Each has their own tax implications.
There are some alternative methods of calculating how much of the distribution and therefore the interest expense falls under this category, but the bottom line is that it is very important to keep track of. It also requires different reporting of that separate interest expense on the K-1 each year so the partners know they have the obligation of tracing that interest expense to however the partner used the distributed proceeds.
I typed all this up and realized Mr Brooks has left the building and posted this 6 months ago, but hopefully someone else will find this useful!
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Mary Smith
Member since 2025 · 1 post · 0 votes
1y
I have similar question- We own MMLLC (husband and wife) and would like to cash out refinance. Basis 525K Cashout 725K We are owed 200K due to personal funds invested
We want to purchase 2nd home
Questions:
1) Since our basis is less than cashout, will we owe taxes or can the money owed us be used to offset difference?
2) Can we not pay anything if buy 2nd home in same LLC?
3) If we both die, will our kids have to pay tax on this refinanced money?
4) Will we be able to deduct interest on new note(cashout refin) as well as note on 2nd home?
Greatly appreciate any/all insight.
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