Just finished a flip with a partner...now what?

Question

A friend and I just finished a flip with pretty much a 50/50 split arms length agreement.  Everything went fine, no arguments or problems.

The question(s) surround the taxing and distribution of funds.  Both the hard money loan and the property are in my name.  My partner and I set up a joint bank account and 90% of transactions went through that account.  The remaining 10% or so were purchases on our personal credit cards that were reimbursed by the joint account.

Assuming we each put $40k in and we're netting $120K at the closing, what is the best way to distribute and pay taxes on the profits?

My current plan is to deposit the $120K check to our joint account then each of us take half the $ in the account and close it out.

How would we handle this so that each of us gets our initial $40k investment back and each of us pays taxes on our $20K profit separately?

Any thoughts/suggestions would be most appreciated!!

Steven Hamilton II · Answer

Ann,

A partnership is a partnership is a partnership.

A big reason: Any receipt that has the partner's name on it would be reported and disallowed on his personal return if audited.
Yet another reason: This would not accurately represent their situation. The tax consequences could be entirely different if one partner just financed the deal and the other did the work.  One would pay SE tax, and the other would not.

The moment you enter into a partnership, verbal or written, you are partners.

-Steven the Tax Guy

Ann Bellamy · Answer

Question to Steven Hamilton II and the other accountants out there:

Couldn't Michael Siekerka simply report all the income and expense on his own return, since the property and loan were in his name, and then 1099 the partner for his share of the profit?  If not, please elaborate.

Thanks for the input

Account Closed · Answer

The basic answer is you formed a partnership and will file a 1065 and issue k1's to you and your partner.  It sounds like your "books" on this deal were a little scattered so you may want to get everything organized and take it to a CPA if you've never filed a 1065 and k1's.

The income on the k1 will be picked up on each of your individual tax returns and you will just pay the taxes when you file your 1040.  Tax wise it doesn't make a difference whether you deposit the money into the business account or not - that doesn't affect tax liability.  If you don't plan on doing any more deals together then by all means deposit the check from closing and cut checks to yourselves for the balance when you close the accounts.  That won't be a problem at all.

If you intend on continuing to do deals like this in the future, I'd probably get a little more legit, form an LLC, draft an operating agreement and keep a proper set of books to make your lives easier in case of an audit or lawsuit.

Let us know how it goes and congrats on the profit!  Profit is always good!

Steven Hamilton II · Answer

Michael,

The answer you asked for:
The moment you two agreed and commingled in the transaction you have a partnership even if no written agreement exists.
You will be required to report all information and transaction regarding the partnership on Form 1065 partnership return.  The income and expenses will all be reconciled and show on the 1065 that will then flow to Schedule K-1 which will be reported on your individual tax return showing the income/loss. I prepare returns and represent people and businesses before the IRS.

-Steven the Tax Guy

Your guide to IRS laws, rules and regulations.

Michael Seeker · Answer

Thanks for the info guys!

I found this article which seems to point me more towards filing Schedule D http://ezinearticles.com/?How-Will-You-Be-Taxed-on-a-Flip?&id=2430929

Any thoughts from a tax guy?

@Jeffrey - I realized this wasn't the best approach too late to do anything about it.  Going forward I probably won't partner up on flips, only on rentals.  If I do partner up there will be an LLC with an OA drafted by an attorney.

Account Closed · Answer

If in the future you decide to work together with a more complicated arrangement, then I suggest using an LLC (to hold title) with an Operating Agreement written by your attorneys. The OA will cover management duties, and splits of income and expenses according to preferred/common class of membership. When the property is sold, the title company wires (or writes a check) for the net proceeds to the LLC. Then the LLC can disburse the proceeds according to the OA. Your CPA will help with accounting for taxes and profits. This will avoid commingling funds in personal accounts or across multiple projects, and greatly simplifies accounting.

Patrick Snyder · Answer

I'm not an accountant either, but i believe you would fill out a K-1 IRS form...

Steve L. · Answer

You can just put whatever you made on that particular property on your taxes and your partner would be responsible to do the same.

So if you made 20k, on your Schedule E (I think), you just should 123 Main St, a 20k short-term capital gain.

The partner should do the same, but if he doesn't and you get audited you should have a copy of the joint venture agreement and the accounting for that property.

As disclosure, I'm not a CPA.