Capital Investment or Personal Loan?

Question

Good afternoon Bigger Pockets members! We are a start-up partnership Real Estate Company and I have a question in regards to taxes as it would be our first year filing. Our partners (married-couple) put forward personal money of $16k to buy our first two rehab properties. A month later, we received $24k from Angel Investors, at that point our partners paid themselves back $15k but left $1k in the company. Was their contribution considered a loan or capital invested? How would this be handled when filing taxes? Thank you for your time!

Alejandra Macias · Answer

@Simcha Davidman Thank you for your reply! No there was no legal written document by our partners other than the Purchase Agreement of both Properties. By your statement that whether it was a repayment of a loan or withdrawal of capital are non-taxable events might answer my question. In any case, I will also seek a professional for further questions. Thank you so much for your help!

Michael Plaks · Answer

@Alejandra Macias

Apparently I misunderstood the whole thing. So now it seems that there're two couples involved: you and your spouse owning 50% and another married couple owning the other 50%. The role of the three investors seems to be that of lenders without an equity stake.

What remains unclear is your contribution to the partnership and the allocation of the investors' money. Either way, this is more complicated than we can handle on this thread, I'm afraid.

And thank you for considering our services, as you mentioned.

Alejandra Macias · Answer

@Michael Plaks Michael! What a surprise! I was actually looking to book an appointment with you in Houston but was going to wait until Monday to call since it is the weekend. Nonetheless, now that we are here, I live in Port Arthur TX, I may have confused the question with the Angel Investors, which we had a total of three investors with a promissory note of 7% interest and a deed of trust. However, in a sense they are irrelevant, the real question is more towards our partners who have a 50% interest in the company, who purchased the two properties with their money but paid themselves back when the Investors gave us funds for the project. Hopefully, that is more clear. From your last case, it seems to me like we simply borrowed money from them on pure trust without any real conditions, which would be likely the case that it is a non-taxable event. I appreciate your time and response!

Michael Plaks · Answer

@Alejandra Macias

We do not know enough to give you a good answer. For example, if you live in a community property state, your LLC will probably be disregarded for tax purposes. You will file your taxes as if no LLC existed. Your question most likely disappears in this case.

Another critical issue is the nature of your "angel" funding. Was it structured as a loan? Did they acquire an interest in your property? Did they acquire an interest in your LLC? These answers matter a great deal. Warning: even if you answer these questions, there will be more if we want to get it right. Besides, your answers may not be correct from the legal and accounting angle without a review of your documents. What you call angel funding may not be. Structuring outside funding is not an easy task if done properly.

On the other hand, if you simply borrowed money from family who gave it to you on pure trust without any real conditions, and all you want is a short (but possibly incorrect) answer - then it is likely that you will not owe taxes on pulling out this $15k and will not have to report these details to the IRS.

Simcha Davidman · Answer

@Alejandra Macias welcome to BP!

Was there a written document regarding their investment? If there was any sort of contract, I'd expect it to state what the contribution was. If it was a loan, I'd assume that this was a repayment of a loan, which is generally a non-taxable event. If it was an equity investment, I'd assume that this is a withdrawal of capital, also a non-taxable event.

On the other hand, was this angel investor essentially a buyout of a portion of their equity? In that case, then I think there would be a capital gain if they sold their shares at a profit.

Disclaimer - I am not an accountant, and I am not providing you with legal advice. You may want to seek a professional opinion.

Good luck!