Best way to structure

[Justin H.]

I apologize in advance for this being a long post. In short, I just bought my first property a couple months ago and am trying to figure out the optimal way to structure it as well as future rental properties with capital assistance from my dad along the way.

Background
I am a new investor and like most new investors would like to buy as many cash flowing properties as quickly as possible. My biggest constraint is cash. My dad has been a buy and hold real estate investor for the past 30 years owning between 2-5 properties at a time. He is starting to near retirement, but has quite a significant amount of equity available in some of his properties that he can pull out using floating HELOCs at great rates right now. It seemed to me like there would be a win-win opportunity where I could use some of his cash to help accelerate my investing and he could earn a greater return on it than he is currently or could elsewhere. I mentioned this idea to my dad and he was very receptive to it, we both agreed we should do things by the book and paper everything correctly from a legal perspective. I asked him what his thoughts were on how to structure things and I mentioned if I could find good cash flow deals that could support more than the 80% first mortgage I could get a second mortgage in effect from him that would be subordinate to the first mortgage and could have a floating interest rate at a higher interest rate than his floating HELOC interest rate, that way he would just earn a spread on the money he lent me. He said that was fine, but that he would also like to participate in the equity since there would be a better return there.

The Lawyer's Advice
Before closing on my first property I met with a local real estate attorney whose office does a lot of closings and who is heavily involved in the local REIA and was recommended to me by other investors. He sat down with me for an initial consultation that lasted about an hour to discuss my goals and answer any questions I had and even gave me some advice and tips he had learned from personally investing in real estate. He did not charge me for this consultation and said that he would also set up my LLC for free and that e-mails and calls were free along the way, he only asked that I use him for closings because that is where they made their money. He recommended buying properties personally for better financing terms and then after a couple months transferring them into an LLC for asset protection. I asked him about this triggering the due on sale clause, he said technically yes, but that in all of his years and all the transactions he had only seen it happen a couple times. I recalled my loan officer even making a remark that she expected me to transfer the property to an LLC after closing so I'm not worried about the due on sale clause when transferring to an LLC.

I then mentioned to him wanting to use my dad's capital and the possibility of structuring the first property as selling him 25% of the equity and then him making a loan as well for additional dry powder for me to do my next deal with. I told him I wanted to do more deals in the future and wasn't sure how they would be structured. He recommended both my dad and I set up separate LLCs and then after I closed on the property I quitclaim 75% of the deed to my LLC and 25% of the deed to my dad's LLC. They would each be single-member flow-through LLCs and this would negate us having to form a partnership which would be more paperwork and require an additional tax filing. I asked him about the accounting of it. He said that 75% of revenue and expenses would flow through to me and 25% would flow through to him. I asked him about a checking account and how the actual money and funds flow would work. He said we could set it up however we wanted but it would be fine for my LLC to collect the rent and pay the expenses and then settle it up with my dad's LLC on a regular basis. I asked if he had a JV agreement or something that we could use to put everything down on paper, he said no he didn't, but that I could just write up how I wanted things to work and he would take a look at it. I wrote up a document covering some basics including minimum cash requirements, distributions, party responsibilities, governance and management and sent it to him and he said it looked great.

Accountant's Advice
With the end of the year approaching and still haven’t done the transfers I was wondering if we could just wait until the new year to do the deeding to the LLCs to make 2013 tax reporting simpler or if there would be some advantage to doing it in 2013. I contacted an accountant who the attorney had recommended to me. I explained the situation and my plans to do more deals in the future and the proposed relationship with my dad and structuring it as the attorney suggested. He didn't really like the set up and thought it was irregular. He suggested there should be a partnership return and it would be easier to just set up one LLC where I was a 75% owner and my dad was a 25% owner. He alternatively suggested we could have three LLCs with one LLC being the partnership LLC and each of our LLCs owning a percentage of it.If we wanted to alternate the ownership percentages then we would have to have a different LLC for each alternate percentage.I didn’t like the three LLC scenario.Under the two LLC scenario the accountant said we would file a partnership return and send my dad and I a K-1 to report on our 1040s. He thought that with the attorney-recommended solution the monthly reconciling with my dad's account would be very difficult and cumbersome, especially when we acquire new properties. He also thought that if my LLC was the one collecting all the rent and paying all the expenses it would seem to have more liability exposure. I asked him how the transferring of the property to the LLC and my dad's payment for 25% of the equity would work. He said I could contribute the property to the LLC and then my dad could transfer cash to the LLC for which he would receive a 25% interest in the LLC which would give him 25% of the equity in the property as well as in effect assuming 25% of the mortgage for the property. I told him this seemed like a much cleaner solution and wandered why the attorney hadn't recommended this, we speculated perhaps it was because I had told the attorney I might not necessarily be locked into my dad having 25% of every property and that it may depend on our relative cash available for investment at the time of the purchase and that the attorney's solution would make it easier to vary the percentages for each property.

My Thoughts and Questions
I agree with the accountant that with all the revenue and expense coming into my LLC and me having to reconcile with my dad every month this may get complex and burdensome with multiple properties, especially if they are different percentages. It also would seem with the accountant's solution of one LLC it will be difficult in the future to secure favorable financing with me buying personally. Would it work under that scenario for my dad just contribute necessary capital to the LLC in advance of the closing for the next purchase and then I use that capital along with my own cash in the LLC from retained earnings for the closing that is done in my name and then transfer the deed to the LLC?

It seems the cleanest and least complex thing to do would be for me to own 100% of the LLC and the LLC to just get a loan from my dad. Would there be a simple way to structure the loan with some kind of equity participation kicker that would be negotiated for each property purchase in advance?