Canadian Capital Partner for flips & investments - how to structure?!
Real Estate Broker · Miami-Denver-Austin · Member since 2015 · 91 posts · 32 votes
Hi there. I have a quite ready & willing capital partner who is a Canadian citizen. Actually a small group of Canadians. If we were to partner in such a way that included them providing capital and our team doing the work here in the US, what would be a logical way to go about this from a business entity perspective?
Work in the US will primarily include fix & flips, as well as, some potential long term buy and holds. Lending will be Hard Money in most all cases or all cash.
The business entity, whether an LP or LLC, can originate from Canada if the investors already have one established. Alternatively, it can be set up in the US if there isn't a pre-existing entity.
American lenders are reluctant towards Canadian personal income for debt financing but an existing LP or LLC with a relatively consistent cash flow can be more appealing to them.
It might also be advisable to keep two separate entities if they're the capital partner & have the other entity funnel a % of profit (predetermined) to you, like a fee with a retainer basis.
Given the complexities of cross-border transactions, I'd look to both a cross-border attorney and an accountant.
Most hard money won't care, most work like this:
The business entity, whether an LP or LLC, can originate from Canada if the investors already have one established. Alternatively, it can be set up in the US if there isn't a pre-existing entity.
American lenders are reluctant towards Canadian personal income for debt financing but an existing LP or LLC with a relatively consistent cash flow can be more appealing to them.
It might also be advisable to keep two separate entities if they're the capital partner & have the other entity funnel a % of profit (predetermined) to you, like a fee with a retainer basis.
Given the complexities of cross-border transactions, I'd look to both a cross-border attorney and an accountant.
We run across this from time to time. It really depends on if you are trying to take advantage of a U.S. Citizen's lendability vs. the Canadians' lendability. You can really get it done either way, you'll just get better terms if you have a U.S. guarantor.
My thoughts are that this isn't SO complicated that it has to be pinned down from the jump. This would be MUCH better solved directly with the lender that you are planning to work with. Setting up an entity and making adjustments is really easy and straightforward.
Appreciate the insight Greg and Jude.
@Jude Campbell so having Canadian citizen(s) on a US Multi-member LLC is fair game? They will simply have to file a US tax return and report any income to canada as well?
Canadian citizens can be members of a U.S. multi-member LLC but it would come coupled with tax and reporting complexities.
Deal structure and sizing would have a big impact on path of least resistance.
Hi there. I have a quite ready & willing capital partner who is a Canadian citizen. Actually a small group of Canadians. If we were to partner in such a way that included them providing capital and our team doing the work here in the US, what would be a logical way to go about this from a business entity perspective?
Work in the US will primarily include fix & flips, as well as, some potential long term buy and holds. Lending will be Hard Money in most all cases or all cash.
Canadian here! LLC's a treated differently in Canada than the US, which causes problems. Long story short, it's much better for your Canadian partner if you use an LP.
I did a quick search about it and found more details:
BY POLARIS TAX COUNSEL | SEP 8, 2021 | CROSS-BORDER TAX, TECHNICAL ARTICLES
The limited liability company ("LLC") is a very common US business entity that unfortunately can cause Canadian tax problems for its owners. These problems primarily arise from a fundamental difference in how many LLCs are taxed in the US and Canada. For a Canadian corporate or individual taxpayer who owns an interest in an LLC, there are a few possible strategies to improve the situation.
1. Differing Tax Treatment of LLCs
In the US, LLCs are by default taxed as flow-through entities, meaning that every dollar earned by the LLC is treated as if it were earned directly by the owners. Note that some LLC choose to be taxed differently (see suggestion B below), but this post solely discusses LLCs treated as flow-through entities.
By contrast, Canada considers all LLCs to be taxable corporations rather than a flow-throughs. That means that Canada considers the LLC itself to earn income, while the owners don't have to pay tax until the LLC actually pays a cash distribution.
2. Common Problems
The disconnect between the two countries' treatment of the same entity creates ugly tax results. Canadian individual and corporate taxpayers who own LLCs can wind up with total tax rates in excess of 70% on income earned by the LLC and 50% on capital gains once all cash is in the hands of the individual owner. Those rates are well in excess of the highest Canadian tax bracket.
The technical reasons for the very tax rates will differ depending on the exact circumstances but may include:
3. Possible Solutions
While Canadian taxpayers may be better off avoiding ownership in pass-through LLCs in the first place, some strategies may be available for a Canadian who already owns an interest in an LLC. Because of the complexity of the tax issues and potential solutions, each of these strategies requires detailed tax advice and the following is only a brief discussion.
A. The LLC converts to a Limited Partnership. A limited partnership (LP) is a flow-through entity in both Canada and the US, so it does not have the same problems as the LLC. The conversion is generally tax neutral in the US but taxable in Canada.
B. The LLC elects to be taxed as a corporation in the US. The US and Canadian treatment of the LLC can also be harmonized if the LLC elects to be treated as a corporation for US tax purposes, the same way it is treated in Canada. There are a few downsides with this approach:
1) The Canadian taxpayer needs to have control over the LLC or cooperation from the other owners for the LLC to make the election;
2) Going forward, the US corporation must pay US tax on its worldwide income; and
3) Distributions out of the US corporation are subject to a high tax rate in Canada.
C. The taxpayer reorganizes its ownership of the LLC. The following ownership structure resolves many of the problems:
Canadian individual
↓
Canadian corporation
↓
US C Corporation
↓
US LLC
This reorganization is complex, but may be tax neutral in the US and Canada. However, this structure results in significantly higher capital gains tax cost going forward than other structures.
D. On exit, the taxpayer sells their LLC interests rather than the LLC conducting an asset sale and distributing the proceeds. Selling the LLC units can reduce the tax liability to 26.75% of the gain (with a tax-free return of principal), while an asset sale would result in 53.5% tax on the full sale price.
E. The LLC’s management is conducted outside Canada. Unlike other legal entities, an LLC cannot use the Canada-US Tax Treaty to terminate its Canadian tax residency. To avoid Canadian residency and the accompanying Canadian corporate tax, the board of directors may wish to meet and make decisions outside Canada.
F. The LLC’s documents are amended so that it is eligible for tax free return of capital. In certain cases, it may be possible to amend the formation documents of the LLC so that a Canadian taxpayer can receive tax free return of capital.
The bottom line is that prospective Canadian owners of US LLCs should be aware of the complexity and high tax rates. However, for Canadian taxpayers who already own interests in a pass-through LLC, options may be available to mitigate the tax consequences.
@Zorya Belanger super helpful thank you. My canadian friends were talking about some sort of 'bridge company' they could set up in US. I'll have to double click inot that and all the information you provided. Thank you!