S Corp - Are we doing this right?

Question

Hi BP Community,

Can you provide some guidance on the best way to purchase a rental property given the below scenario? Thanks!

4 Partners planning to purchase rental property using conventional financing. Our lender has approved of our plan to buy the property as a single individual and then transfer the deed to our S Corp. Ideally, the four of us will alternate between purchases. Our question is how do we transfer the funds for the down payment to the individual who will be taking out the conventional loan? The bank doesn't care how the individual gets the funds as long as they are secured in their account 60 days prior to applying for the loan. We're wanting to know if there are any tax implications since the three not taking out the loan would be "gifting" a large sum of money to the individual taking out the loan. Is there a common way to accomplish this? We were told the funds could not come out of a joint account. Our other option is to have the individual have the liquid to cover the down payment and then send them our portion of that payment after the fact but again are worried about potential tax implications for moving that large of an amount.

Any insight you can provide would be greatly appreciated as we look to begin our journey. Thanks!

Jake Hottenrott · Answer

First thing is first, why an S Corp? Typically this is not a good choice for passive investments.  Who suggested this to you?

If you are round robin providing funds, why not buy individually?

The bank approves the personal purchase then transfer to LLC now, but is the due on sale clause still in the loan docs?  If so, have you essentially notified the bank that you’ve triggered the clause and they can call the note due at any time?

You’ll definitely need to work through this with a tax professional.  You have a lot of things in play and I’m not sure it’s going to be as straightforward as you think it will be.

Ashish Acharya · Answer

S-Corp:

you can’t do special allocations of expenses/income when needed.if you ever take property out of the Corp, it is considered sale. And you will a Phantom income.

you don’t get basis for debt on the asset. Meaning in certain situation,  if you distribute cash, your would have to recognize income. Vs if this was partnership, that wouldn’t happen(no income). That is a general statement.

Natalie Kolodij · Answer

Jake nailed it- who suggested an S corp for holding an appreciating asset?

Typically a partnership is a preferred structure for multiple reasons.

Michael Plaks · Answer

Account Closed

The 4 of you deposit $10,000 each into the LLC account. The LLC then transfers $40,000 into the personal account of the one who will be on the loan. Rinse and repeat.

It sounds simple, but there're other things that matter. For example, documenting partners' decision to use the business funds in this fashion and jointly accept the responsibility for the loan. An operating agreement protecting each other's interests. An insurance plan. Etc.

Eamonn McElroy · Answer

Account Closed

"4 Partners planning to purchase rental property using conventional financing. Our lender has approved of our plan to buy the property as a single individual and then transfer the deed to our S Corp. Ideally, the four of us will alternate between purchases."

You'll want to double check the loan docs.  One individual acquiring a leveraged property, then subsequently transferring the property to an LLC in which he/she is not the sole owner would almost certainly violate the due on sale clause of most mortgages.

You really need to engage a professional.  Transferring money to the individual buying the property instead of contributing it to the LLC gives you no basis in the LLC, which can cause multiple problems.

Agree with other pros that an S Corp is generally not going to be optimal here based on the face value of the facts.

I assume there is a reason you're attempting to structure it like this...perhaps to obtain more advantageous financing.

Account Closed · Answer

Sorry I had my terminology wrong. We plan on leveraging a Series LLC (SLLC). We mainly are trying to determine how we would transfer funds to the individual who would provide the down payment for conventional financing (lender has approved transfer of deed to a LLC so we do not have to worry about the due on sales clause). We're unsure if that we be considered gifting and if there would be tax implications to the individual receiving the other 3 partners portion for the down payment. I hope that clarifies the question and intent. Thanks!

S Corp - Are we doing this right?

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