Best company structure for my situation?

Question

Hello, and thanks in advance for reading!

I am a real estate investor in Central Texas, and have thus far been a Sole Proprietor come tax season. We are starting a new family business constructing, and selling Spec homes as 3 partners. I know I am going to need to meet with a CPA eventually, but I am hoping some of you can provide me with some preliminary knowledge on what the best way to structure the business would be for tax/liability reasons.

There are 3 of us all equal partners that ideally want to just split net profit on each deal equally unless that is a horrible idea tax wise. Should we be looking at an LLC, or other business structure?

Thanks Again!

Vinod Dasani · Answer

Multi-member LLCs passes through the profits and losses directly to its members via K1.  Thus, the corporation does not get taxes.  All profits and losses are transferred over to its members based on their share and individual members pay the taxes on the profits based on their income bracket

Vinod Dasani · Answer

Multi-member LLC would be my recommendation.  This would keep your personal properties and flips independent of each other as well.

Dave Toelkes · Answer

@Cole A.,

I suspect you are reading about the HOME mortgage interest deduction on Schedule A that governs the mortgage interest deduction for a primary residence.   For example, I buy a house near me for my elderly father to live in rent free.  My father makes the monthly loan payments directly to the lender.  Even though the property is in my name, and I am liable for the loan, I am not making the loan payments so I can not take the home mortgage interest deduction for a second home on my Schedule A.   Even though my father is making the loan payments, he can not take the home mortgage interest deduction either because he is not legally liable for the loan.

Your question concerns a business deduction for loan interest for either a property flipping business or a property development business.  In your case, you don't have any income until the partnership sells the first spec property,  Your partnership agreement will have to describe how the partnership will make loan payments for property pending sale.  Will all expenses be shared equally by the partners, or will the loan guarantor make the loan payments, then get reimbursed from the proceeds of sale before sharing in the remaining net profit?  Will all the partners make a sizable upfront cash contribution to the partnership for operating expenses which will cover the loan payments?  For the partnership tax return, you may not have any mortgage intrest expense until the spec property is sold.  At that time, all the accrued interest and other holding costs are included in the cost of goods sold.

Make sure you and your potential partners have this discussion with your accountant to ensure that each of you have a clear understanding of each partner's responsibility and obligations under the partnership agreement in addition to the accounting and tax reporting procedures.

Cole A. · Answer

Thanks for the response. I have read some articles online stating that the mortgage interest/taxes can only be deducted from the individual(s) legally obligated to pay (i.e., mortgage guarantor), and not the other individual(s) with an ownership stake in the property who don't technically guarantee the loan. But, I have yet to see how that is actually defined in the IRS code.

Vinod Dasani · Answer

@Cole A. - no, basically the corporation files the returns and all profits and losses goes on the corporate tax returns.  The final profit/loss then gets distributed to the members based on their share.  The LLC pays no taxes and the profit/loss gets transferred to members via K1

The returns are not affected based on who guarantees the loan.  The share is distributed based on membership percentages

Cole A. · Answer

How does this change when one of the LLC members is the guarantor of the financing used for the investment, even though all 3 are owners? Can only the note holder deduct interest and tax expenses? Thinking more along the lines of long term investment, not necessarily the build and sell. But seems the similar rules would apply if you're holding on to a construction loan 1+ years.

Colton Joseph · Answer

@Vinod Dasani Thanks Again! I was just doing a bit of research on that. Definitely seems like a good Idea to set up to protect personal assets since income will be taxed basically just as it would without the LLC!

Colton Joseph · Answer

Thanks for the input @Vinod Dasani @Daniel Hyman Would a multi-member LLC avoid being tax twiced etc. I.E if the company pays taxes on total net income would each member have to also pay income tax, or is it just shown on a form (K1?)? Sorry I'm new to the legal/tax side of the business so all opinions are appreciated!

Best company structure for my situation?

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