How to co-own when she buys into my existing property?

Question

Hello BP--I own a SFH rental property valued at $800K with a mortgage of $277K on a 1-yr ARMcurrently at 5.125% amortized over 25 years with a $3600/month gross rent.

A friend and I are considering co-ownership: she would cash out her annuity for $400K for a 50% share of my property and receive half of the net rental income, minus $200 which I would retain for managing property. We would re-deed the property as Joint Tenants in common (vs LLC because after the current tenant leaves in August, we would move-in and rent out the basement and would want to obtain an owner-occupied cash out refi loan to pay off /down our respective debt. Not interested in additional real estate investment).

How would the IRS view the $400K I would receive from her? Would it be taxed as ordinary income (yikes!)? I do have an LLC for my B&B business--it doesn't own property ; if she invests in that LLC would the $400K be taxed? What if we created a new LLC and she invested that cash? Also, I may use the $400k to pay down a $1.2 million principle on my B&B instead of paying off the $277K mortgage (with my friend's approval and with re-deeding this SFHrental in both our names). What is the best way for us to co-own this property paid for by her cash and my equity?

Eamonn McElroy · Answer

It doesn't make too much sense to sell a portion of the property if you're going to contribute it to an LLC (theoretically taxed as a partnership).

Generally no gain or loss is recognized on transfer of assets to a partnership. It may get a little complicated if you do a refi and distribute the proceeds from the partnership, which is called a "debt financed distribution" in the tax world.

That should give you a starting point... Your tax pro should be able to answer more specific questions as he or she will know your individual facts, circumstances, and goals.

Dana Powell · Answer

thank you Eamonn for your reply. Perhaps we could put the TIC owned property into an LLC. Any feedback on how to structure the transfer of the $400K to minimize tax implications for both of us?

Eamonn McElroy · Answer

$400k is a lot of money to just get TIC and a handshake...

I would insist on an LLC with an operating agreement if I was her. May not meet your goal of the owner occupied refi, you'll want to clear that up with your bank.

How to co-own when she buys into my existing property?

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