LLC creation: any gotchas for this joint venture?

[Jake Faris]

Seeking advice here on the best approach, any gotcha's that I'm missing, and overall sanity check... 

My business partner owns a residential property in Seattle outright (the title is in their name and they paid all cash). We plan to share ownership of the property as I am going to invest my money into developing (building a Detached ADU in the back) and re-modeling the property so that we can collectively sell it for a profit. My proposal is to do the following:

1) Create an LLC in which my partner and I are both owners/operators
2) Have the title of the property put into the name of the LLC via quitclaim deed
3) Have the Operating Agreement of the LLC outline ownership based on shares ownership model. Currently, my partner owns 100% of the shares based on him putting 100% of the cash (let's say $1,000,000) into the property. However, for every dollar put into the property, a net-new incremental share is added to the share pool; that share is then owned by the giver. So, If I put in $500,000, the total amount of shares rises to $1,500,000 and I own 500,000 shares while my partner still owns $1,000,000.
4) When we sell the property at a profit, the net profit will be distributed based on a percentage of share ownership.

My understanding is that once I am a partner in the LLC, any money that I put into the property will be tax deductible. I'll need the LLC to do that, but are my assumptions here all correct? What might I be missing here?

Thanks for your help!

[Greg Scott]

You have two unrelated questions here.

Question 1

My impressions of your LLC setup is that having the ownership change over time is too complex with the potential for misunderstanding. It would be far simpler to put the $500,000 in a bank account owned by the LLC and you immediately own a fixed percent. The bigger issues that need to be addressed by the operating agreement are how you deal with disagreements. What if you sell for less than $1.5M. What if you need to inject more money? What if your partner wants to sell before the rehab is done and you want to keep going? All those things, and more, need to be ironed out.

Question 2

From a tax perspective, if you put a dollar in a business and when you sell you get a dollar back, that is a $0 profit, so from that perspective there is no tax.  If you sell at an actual profit, yes there will be tax.  

You really should talk to a CPA and show them the details of this property and how much depreciation has already been taken on this property.  Because you are essentially buying into an existing business, the sale of it could generate a disproportionate amount of tax for you given your time in this deal.