Chartered Financial Analyst (CFA) · Boston, MA · Member since 2018 · 40 posts · 14 votes
Good Morning All,
Need some advice please.
A good friend and I are buying a rental property at $165K and structuring it as follows:
- Formed an LLC in the state - both are 50% owners
- I am contributing the down payment $16K
- He is contributing set up costs (furnishings, etc.) - $7K
- My name is on the loan
- The LLC holds the property
To get us back to a 50/50 equity split in the property, I would like to reimburse 100% of the monthly profits to myself from the LLC until ($16k/2) ($7K/2) = $4.5K is reached. Given the points above, this would mean we both have invested about the same $ amount in the property. Does this make sense?
If the $16K is contributed by myself to the LLC to buy the property, can I pull out up to $16K effectively tax free since it's paying back my initial investment? Almost like I lent $16K to the LLC for the purchase and it's paying me back?!
Palo Alto, CA · Member since 2017 · 230 posts · 200 votes
7y
I recommend not to get into business partnership with good friends or family, usually they don't end well when the business situation turns bad. Some times decision are no longer business decisions, but include other factors. As an outsider, you are being taken advantage of in the above agreement.
Some issues with this set up (or not clearly defined).
1) What happens if property is losing money? Is agreement for both of you to cover loss 50/50. Seems your friend don't have as much cash as you, or you would not have above set up. What happen if your friend don't have the money to cover the loss?
2) Why is loan in your name only? This implies you and your family are taking on all the liability and your friend can walk away if something catastrophic occurs. I recommend taking a commercial loan and borrow use the LLC.
Around 2008, a friend of mine had similar set up of 50/50 ownership agreement with her friend (who max out # of loans that person can take individually), so loan was in my friend's name. When the property dropped value by over 35% by 2010, that supposedly good friend just walked away. My friend is stuck with the house and bad loan. Even after 10 years, she is still underwater by over $100k.
3) What happens 1 partner dies or disabled? Is it defined in the LLC operating agreement. Does other partner have preference to purchase?
4) What happens one of you want to sell and the other don't? I like to be in control, so normally I would suggest at least 51/49 (maybe 70/30 - based on 16k vs. 7k initial capital) set up so at least you are in charge of the decision, especially if you are putting in more money and taking on all the risk.
1) We have a separate signed agreement detailing that we are 50/50 responsible for losses. The amount we are talking about is not enough to make me that worried - i know that's probably not the best way to justify this.
2) We can get better terms on the loan if I take out the loan in my name. The plan is to refinance out of the original loan into another loan once we have 80% LTV.
3) We have an Operating Agreement that defines what to do in these situations.
4) This is actually a very good call and I will work that into the agreement.
Thank you for your response and good food thought.