Hello, I'm looking to recruit investors in a house flip, similar to a crowdfunding scenario. So my question is whether there is any tax liability to those investors.
Assume one particular investor gives me (or my LLC) 10K. Then I pay back the 10K, plus a percentage of the profit from the eventual sale. Of course, since the payback is variable, perhaps the investor holds a tax consequence, even if I pay the capital gain / ordinary income tax.
Whatever the investor receives over and above his $10k investment is taxable income to him (and also a deductible expense to you.)
Seeing how little you know at this point about recruiting investors, I highly recommend you don't try it on your own. Get some help, please: from an attorney, an accountant, or an experienced investor.
Whatever the investor receives over and above his $10k investment is taxable income to him (and also a deductible expense to you.)
Seeing how little you know at this point about recruiting investors, I highly recommend you don't try it on your own. Get some help, please: from an attorney, an accountant, or an experienced investor.
@Michael Plaks
So I could just have the investor fill out a W-9, write him a check with his original investment and whatever profit we agreed he’ll received? Then he can claim it as his income and file taxes on his own?
My CPA is saying I should open a whole new LLC with the investor as a memeber and then we all file a K-1. Have you heard of this way?
Thanks.
So I could just have the investor fill out a W-9, write him a check with his original investment and whatever profit we agreed he’ll received? Then he can claim it as his income and file taxes on his own?
My CPA is saying I should open a whole new LLC with the investor as a memeber and then we all file a K-1. Have you heard of this way?
It's a good idea to get his W9. But reporting is really the other way around: he should issue you Form 1098 if he is a professional/frequent lender. If he is just a casual one-time lender, like a family member, no reporting is required. Interest is still taxable income to him and a deduction to you. Keep the paperwork of the lending deal.
What your CPA suggests is a more complicated solution: treating your deal as a partnership. Not wrong but much more complex.
Yes, 1908 Form is for expenses. Also, 1099 Form should be given to the investor as well. 1099 Form doesn't have the details such as capital gains/loss. CPA says it's a lot cleaner to run the investment this way. It's not complex really to do, for my particular situation I am set to close escrow by the end of November, so I don't want to risk time for switching the buyer's entity on the contract if I don't have to. CPA also mentions investor pays ordinary income rates versus capital gains rates on his tax return, if simply handing him a check with 1098 & 1099 forms. It seems like it's the proper way to go about it. Currently have a client in SF selling a 5-unit commercial/residential and the name under title is the 'the property address LLC'. So that tells me they have their business structure set up the same way. An LLC was created for the individual property investment & they'll write out K-1's to each member after the sale and from there close the LLC. Repeat.
Unfortunately, your description includes several misunderstandings which are too long to break apart in an online post. I'm not sure whether it's your interpretation of what your CPA said or, worse, your CPA's opinions that are off - but they are off.
Please email what you just posted to your CPA and have him straighten it out for you. Or maybe even get another accountant's input.
Sorry for not doing this for you right here, but I would need to type up couple pages of explanations to respond to your most recent post.
@Ramsin Jacob - your first misunderstanding is that you're stating a flip is subject to capital gains tax. It is not. A flip is a business, so it is subject to ordinary income tax.
The IRS does not care if you buy a house, improve it and resell it or you buy bread, mustard and lunch meat and make sandwiches - to them it is the exact same business model.
You can search the vast number of writings I've done on this subject on Bigger Pockets.
I agree with your CPA in all aspects and here is why.
Running it through an LLC: If this project comes in at a loss, how is your investor going to prove out their share of a loss or report it? The K-1 from an LLC will do so where the lack of a 1099 does nothing for your investor. Also, an LLC should have an Operating Agreement that breaks out everything that has to do with your partnership. This will help keep both of you out of court or, if you do end up in court, helps the judge to mediate your argument. I don't know if your current arrangement has such a document, but it should.
Investor pays ordinary income: Yes, this is true. So do you. You also have the added burden of Self Employment Taxes if you are actively participating in the business.
In my opinion, you've jumped into a business without understanding a lot of the administrative aspects of it. Go back to your CPA and start to follow their advice. They sound knowledgeable and like they have your best interests in mind.