IRS Audit & Partnership

11 Replies

Hello BP,

I am considering partnering with an individual who is bringing me a deal (apartment complex).

However, he told me that he is being audited by IRS. Is this a deal breaker for me?

I am concerned that IRS can go after this partner and that somehow will affect the entire partnership. Another question is lender's reaction to this issue. Would a lender (Fannie or Freddie) automatically disqualify us? Last but not least are potential investors - are they going to pass on the deal when they see that one of the GPs are being investigated by the IRS?


Thanks
Nick

Caveat emptor!

If I'm a gambler I would say that's a high risk. Fed liens go on anything he has his name on. 

This not a settled matter yet. The guy owes X according to the IRS but he and his lawyer are trying to prove that he really owes much less if anything at all. They don't expect to reach a final settlement in less than a year.

You do not need to formally partner with him. In fact, I would recommend that you do not make him (or anyone else) an equity partner unless you must. Too many reasons, and his IRS problems just add another reason to avoid it.

Instead, just have an agreement on his compensation once the deal is sold. Assuming he will not demand an equity stake.

Clarification: being audited is not a problem on its own - for you or for the lenders. However, if he loses the audit and is unable (or unwilling) to pay the IRS - then it can become a problem.

Good point @Michael Plaks . He actually wants sponsor equity position (%% of the sponsor entity). So, you're saying: just have a separate agreement with him that would mimic payments of his sponsor position? Something like a consulting fee? 

Would this consulting fee count against property's NOI or against sponsor entity distributions? If the latter, what is the tax treatment for this fee?

@Nick B.

I'm not sure what you guys call "sponsor entity position" but, in my suggestion, you own the holding entity 100%, so your payments to this person become a P&L (profit & loss) item when made. In your terms, count against NOI.

The holding company is comprised of a general partner and limited partners. General partner is what I call a "sponsoring entity". General partner has a profit share of the whole enterprise but contributes no initial equity. 

Paying someone a consulting fee from the property itself reduces NOI and the value of that property.

Paying out of the profit share of the general partner does not affect NOI as it is counted below the line.

We are not on the same page, @Nick B.   GP or LP - they are partners. I advocated not making him a partner of any flavor.

If he is a partner (again, any kind of partner), he gets a % of the profit - which conflicts with my suggestion. You can do one or the other. My suggestion: no partner, just a payment. Your suggestion: partner and % of profit. Your choice.

I already mentioned the reasons for my suggestion and my thoughts on being audited (no problem today, could become a problem later)

I am not making him a partner. 

His payment either comes directly from the property thus reducing NOI or it comes out of GP profit share as a payment to a vendor or something similar. The later does not affect NOI.

GP would cash its distribution check made to GP and then pay this guy out of GP's account. This way the payment does not affect NOI.

I don’t know many successful business owners that have not been audited at some point in their career. I would not say it’s a deal breaker because he was upfront with you in the first place. I would be more concerned if he didn’t tell you and you found out later down the road. If you do decide to partner on a deal speak to an experienced attorney who can give you proper advice on how to structure the deal.

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