How to structure JV

Question

I am planing to enter into a JV with another partner and need some opinions on the best way to structure this deal.

1.  I will by the LAND with my own funds for $420k (NYC area).

2.  Will work with the architect on plans and get permits (will take about 1 year).

3.  Once the plans are approved - will transfer the property into a LLC and my partner will pay me 50% of the cost basis (~$210k) for the the 50% stake in the newly formed LLC....

Will this trigger a taxable event?  Is it better for me to form LLC at the time of the purchase and buy the property under LLC name?

4.  We will then contribute equalty 50/50 towards the construction cost (which will be about $450k).

What is the most 'efficient' way to structure this deal from the TAX perspective and LIABILITY point of view?

Tyler W. · Answer

I see your point.  And yes, they are taxed differently.  If you transfer property directly to an LLC in exchange for an interest, it is considered a tax-free event.  But what you've described is actually the sale of some LLC interest to a 3rd party.  This will be a taxable event, but only to the extent that those assets grew in value.  For instance, if you buy the property today for 450k, but a year later it becomes worth $550k, the $100k gain will partially be subject to tax.  But if there's little to no growth, then you don't have to worry about the taxes on the subsequent sale.

Going to your question about how to structure this kind of JV, it's hard to summarize my thoughts here.  I think the method you described would work, but I would be more concerned about outlining the "deal" between you and your partner.  You want to have clear terms in your operating agreement as to what events would trigger a buy-out, whether the operations will be decided by all members or whether you alone will be the managing member, and a number of other issues.  Setting up the entity is the easy part.  It's these controlling provisions that you want to nail down correctly.

Mike Rash · Answer

Hi Tyler,

I would like to clarify one point....

You mentioned the following:

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One more thing to think about: In your hypo, if you contributed $450k worth of property, and your partner then contributed half ($225), you would in fact own a 2/3 interest in the LLC and your partner would own 1/3. (Your contribution: 450k; Partner's contr: 225k). To make this a 50/50 deal, your partner would have tomatch your contribution.

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I will first contribute $450k to buy the property.  After one year, the partner will PAY ME $225K for the 50% stake of the LLC where the property will be transferred...  Then we will start contributing 50/50 towards construction cost... so his initial 'contribution' of $225k is not really contribution, but the buy-in towards 50% stake...

Would this be still considered tax free transaction?  What is the best way to structure this?

Tyler W. · Answer

This likely won't trigger any taxable event.  If you contribute cash in exchange for LLC interest under sec. 721 it is a tax-free event.  But if you purchased the property in your name and, one year later, contributed the property to the LLC, this exchange would also qualify for tax-free treatment under 721, but the unrealized appreciation (built-in gain) would be allocated to you, the contributing partner.  This means that when the property is later sold, the built-in gain on that property will be taxed to you under 704(c).  I would suggest that you either purchase the real property with cash and then immediately transfer it to the LLC or have the LLC purchase it directly.  But don't wait to get the property into an LLC.  It will also provide an additional layer of asset protection during this period.

One more thing to think about:  In your hypo, if you contributed $450k worth of property, and your partner then contributed half ($225), you would in fact own a 2/3 interest in the LLC and your partner would own 1/3.  (Your contribution: 450k; Partner's contr: 225k).  To make this a 50/50 deal, your partner would have to match your contribution.

Whenever it comes to large dollar figures like these, it's worth your time and money to a good business attorney to set up the deal.  That's especially true where you have different roles (passive investor v. active managing partner).

Mike Rash · Answer

Hi Eric,

The partner will be managing all construction, hence I am contributing the money initially (carry all risk for the 1st year).

Any suggestions on how to structure this ?

Eric Black · Answer

Hi Mike,

So let me get this straight, you're going to put up 100% of the money, do all of the legwork (and I presume pay for the architect and permits, etc) and carry 100% of the risk for the first year. Then, once all of that work is done the partner is going to come in, pay you 50% of the initial investment and get 50% of the profits? Who is going to manage the construction portion?

I can't speak to the tax and liability but please let me know when you have another project you need a partner for!