Rental Property Investor · Cincinnati, OH · Member since 2014 · 150 posts · 59 votes
I am partnering up with a couple guys who have a successful rental real estate business. I will become a member of their LLC in exchange for the work that I will be performing managing all of the rental properties. I will not be contributing any money to the LLC in exchange for the equity. I recently found out that I will likely owe tax on the FMV of the equity that I receive in the company.
The plan is that I will get 33% equity, vesting over 3 years. So the beginning of year 1 I get 11%, then 11% in year 2, and 11% in year 3. If I understand correctly, I will have to pay tax on the 11% equity in year 1, then 11% in year 2, and 11% in year 3. Alternatively, I can pay tax on the 33% in year 1 if I file election 83(b). I guess doing this is good if I expect the equity to increase over the next 3 years so I'll be paying on today's equity instead of the increased equity in year 2 and year 3.
Has anyone had any experience with this? Any insights or advice that you can share? That's going to be a big tax bill, especially if I pay tax on all 33% up front. But if the business grows substantially in the next 3 years, it could be worth it to pay it up-front. Also, if you know of any alternatives, please let me know. Thanks in advance for all of your help.
Will they also be paying you a salary? Will you be receiving distributions from the LLC?
Yes, we will be splitting profits evenly between us each month as distributions, except for a portion that will stay in the company. This part doesn't vest over 3 years like the equity portion.
You will defiantly owe tax on your percentage of the profits made in the LLC and you will receive a form K1 from the LLC that you will include in your personal income. On the equity issue, technically any increase in wealth is taxable, example you find a diamond ring technally you owe tax on the value of the ring. But what is the value? A closely held rental company what is the real value once you take the liabilities againts the fire sale value of the homes. It's really hard to determine true value." So if I were you, as long as this is not some sort of related party transaction or a way to income shift, I would change the agreement to state you have the "option" to purchase the interest in the LLC at $10 for each %. This example will simplify the tax implications of the transfer. You have probably heard of executives of corps getting stock "options" same principal. Don't think you are dodging anything you are just deferring tax, you will owe the tax when you sell or dissolve the LLC in the future. For example you sell your interest 10 years latter, you will owe tax on any increase in value of your interest over what you originally paid. Good luck.
Yes you will pay taxes on the FMV of equity earned in exchange for your work. So if you earn a $100 stake in the company, you pay taxes on that $100.
I know you mentioned profit sharing, but perhaps there is an opportunity to increase your stake in the profit share and subsequently decrease your stake in the equity share. By earning an 11% increase in the profit share, it's only taxable when profit is earned. On the other hand, the profit share doesn't give you ownership of assets so it may be a disadvantage. But it could provide you with a tax advantage, though without knowing anything about your financial and tax position, it would be impossible to say.