How to Limit Distributions from Real Estate LLC

Question

I am planning on investing into a real estate development LLC as a non managing member for the prospective development of a 90+ unit senior housing project.  The returns and distributions are excellent (2.0 multiple) but will be delayed until year 4.

Ideally, if I had enough capital in my self-directed Roth IRA I could just purchase the unit with those funds and have the distribution return to my Roth avoiding taxes altogether.  Unfortunately, I had to pull the money together out of pocket and am trying to explore the best tax mitigation stragtegies.  I have been told that because the ownership entity is an LLC of which I purchased one unit as a non-managing member, that I will not be able to 1031 exchange into another real estate investment property.  I have heard about the 1035 but most people say that is used exclusively for annuities.

Could anyone offer any other solutions as it relates to how I receive my distributions year 4?  I want to stay in real estate and would like to defer the taxes by rolling it if possible.  I would primarily like to avoid taking all of the capital gain in year 4 as ordinary income and lose close to 50% to our favorite uncle.

Thanks for your consideration in advance BP!

Steven Hamilton II · Answer

Fkln Spees,

You are correct in that the 1035 exchange is exclusively for annuities.  Did you consider the possibility of investing by partnering with your ROTH IRA?  Another solution is to attempt to find someone who will loan the money to the IRA without a personal guarantee in exchange for the interest in the property.  The TIC is an option; however, Based upon what you have said so far that doesn't seem like a favorable set up.

What type of Entity is this LLC set up as?  That is the only way I can actually tell you what you would be looking at. If it is operating as a C-corporation you will look at dividends, if it is a partnership, it will be taxed as ordinary income; however, you will/may have certain deductions that are taken against the income such as depreciation that will affect what is actually taxable.

One option would be to sell your interest in the LLC at the beginning of year 4 based upon the projected incomes and pay capital gains on the Stock gain.

The short answer:  Can I get some more information from you.  What type of Entity is this set up as?

-Steven

Bill Gulley · Answer

Welcome to BP!  Charles Perkins, might be able to tell you.

Brian Burke · Answer

I'm not a tax expert, but the only way I have heard of is if you can convert your LLC interest into a TIC prior to the sale, then do the 1031.  There are some experienced tax guys on this site that can tell you if that really works or if there is a better way.