Distributions or Not from LLC and strategies??

Question

I formed a partnership with an investor and we have $300k sitting in the operating account. Rather than paying a property manager a $1,000 fee to place our tenants in the property, I am doing that and partner told me I could take a distribution for that or write myself a check from the LLC. We have similar items that would allow me to take a fee.

I'm looking for guidance on how to strategically do this.

Since we have contributed $300k to the LLC, and it far in excess of what I am taking out, wouldn't the distributions only reduce our basis in the LLC and have no tax impact on me?

And is there anything that I need to be aware of as far as unequal basis to my partner going forward? I am struggling with wrapping my head around this idea and how that works.

Blake Meester · Answer

@Matt N.

It is very difficult, if not impossible, to adequately apply “general” advice you will find here to your specific situation. The best advice I can give you is to have a discussion with an attorney and tax professional that are experts in real estate. This way you can be sure that you questions are answered by someone with the understanding of your specific fact pattern. Let me see if I can give you some information to point you in the right direction and help you understand the concepts.

On the formation of the LLC. If Partner A is putting in cash and Partner be is contributing services, there may be a taxable transaction upon formation. You really need to look at the LLC operating agreement and understand what type of interest you have. BEFORE you form the LLC, seek some advice to make sure that your choice of entity help to accomplish your goals.

If you go the guaranteed payment route, it will likely be a deduction at the LLC level, and income to you are the individual level. Your LLC agreement will govern the allocations of income and expense (within the limits of the partnership Rules)and the information will be reported to you on the form K-1.

There are many variables that will affect the treatment of the $4,500. It is possible that it could be structured to make it a tax free reimbursement to you.

There are many strategies, rules, considerations, etc.… Seek some professional advice that is tailor to your specific situation. It is much easier to do it right form the begging then going back and fixing a mess.

Blake Meester · Answer

@Matt N.

Your concerns about making an inequitable distribution may be warranted. You will need to look to your partnership agreement for guidance, and then make sure follow the very complex partnership distribution/allocation rules.

The distribution language I most often see is that distributions are made equitable to ownership as a return of capital or share of profits. Many times partners in a partnership with use a guaranteed payment to compensate a partner for services provided to the partnership. The guaranteed payment would be an expense to the partnership and income to the partner. The guaranteed payment route may accomplish your goal here but there are many ways to skin a cat… read your partnership agreement and talk with you tax professional.

I believe Jeffrey H. is speaking to the basis of the property held in the partnership while you are talking about the basis you have in the partnership interest. These are two different things. A distribution from the partnership would reduce your basis in your partnership interest (“Outside Basis”). Partnership taxation is often touted as the "most complex section of the IRC". Difficult stuff!

Linda Weygant · Answer

In general, you can't take unequal distributions from an LLC.

However, for your scenario, you can take a guaranteed payment for the property management portion, then do equal distributions for whatever else is coming out.

The guaranteed payment will be taxed as Self Employment Income and the rest of the distributions will maintain the nature of whatever income it was originated from (sounds like passive income based on your description)

Cameron Skinner · Answer

you get into some crazy IRS rules with unequal distribution from a partnership, I would avoid doing this.

Jeffrey H. · Answer

Your basis is the purchase price + capital improvements made to the property and will only change based on your depreciation schedule.

Taking a distribution from the profits would be added to your ordinary income during tax season and accounted for via Schedule K-1.

Distributions or Not from LLC and strategies??

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