Tax Implications for LLC Sale - Owner Financed

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Tax Implications for LLC Sale - Owner Financed

Nik Divakaruni
Investor · Portland, OR · Member since 2016 · 19 posts · 3 votes

I've got a doozy here.  If anyone has a good solution for this, I will be hugely grateful.

My wife and I are currently the owner of an LLC with 30 doors across 6 properties. We've been approached by a buyer to purchase the LLC from us (and subsequently all the assets) for a price, but he wants us, as sellers, to carry a loan. He's agreed to take over all costs, and will be entitled to all income from the properties during the time he's paying off the loan.

If we move forward with this, I assume we would have to now file a K-1 as the LLC is no longer a pass-thru entity for my wife and me. The buyer will have the full P&L on his K-1.

We still carry a note for the properties (one note, thankfully).  The buyer would, I assume, take out a loan to buy our business.  That loan will be between me and him.  

Here's my question: Since the LLC has the existing note for the properties, and the interest the buyer would pay me would be personal, I would owe tax on the entire interest income from his loan, and since the interest expense on the existing note is through the LLC, I wouldn't be able to offset the two, right?

Further, since the buyer would take over all costs and income, he would be able to write off the interest from his personal loan to me against the business (since it's being used for business purposes) AND would be able to write off the mortgage interest from the bank note (since it's in the LLC).

Is there a solution here, where I can deduct the interest on the note through the LLC, from the interest income I'm making off his personal loan? Also - does someone potentially have a better way to structure this deal so I'm not getting hosed on the tax consequences of the interest income?

Any advice would be greatly appreciated.  Thanks!

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Eamonn McElroy
Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
7y

@Nik Divakaruni

If you're treating the LLC owned by you and your wife as a disregarded entity, selling it to someone would generally be considered an asset sale.

Like @Basit Siddiqi mentioned, there's no reason for you to get a K-1 (i.e. remain an equity investor) going forward as you have sold.  The buyer steps into you and your wife's shoes and you get cash and/or a note in return.

I encourage you to work with your attorney and CPA to ensure that you're both protected during the process and the sale is structured efficiently from a tax perspective.

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  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    7y

    @Nik Divakaruni

    Wouldn't the buyer be responsible for paying the LLC note if he is buying the LLC?

    You should look to see if your bank that is gave the loan to the LLC will allow this.

    I am not sure how K-1's will be involved for you. You should consult with your accountant to see how this will play out.

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  • Eamonn McElroy
    Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
    7y

    @Nik Divakaruni

    If you're treating the LLC owned by you and your wife as a disregarded entity, selling it to someone would generally be considered an asset sale.

    Like @Basit Siddiqi mentioned, there's no reason for you to get a K-1 (i.e. remain an equity investor) going forward as you have sold.  The buyer steps into you and your wife's shoes and you get cash and/or a note in return.

    I encourage you to work with your attorney and CPA to ensure that you're both protected during the process and the sale is structured efficiently from a tax perspective.

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  • Nik Divakaruni
    OP
    Investor · Portland, OR · Member since 2016 · 19 posts · 3 votes
    7y

    @Eamonn McElroy @Basit Siddiqi

    I left out a key detail of this Entity Sale. I need to be at least an 11% owner of the LLC in order to avoid a transfer tax of 5.5%. That's the whole reason we're doing an Entity sale.

    With that said, any ideas?

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  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    7y

    @Nik Divakaruni

    You are making the whole deal a lot more complicated just to provide the convenience of the buyer saving 5.5%. That is up-to you.

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  • Lance LvovskyPro Member
    Accountant · Fort Lauderdale, FL · Member since 2013 · 1k+ posts · 753 votes
    7y

    @Nik Divakaruni

    You will continue as an owner then and receive a K-1. You should consult with your CPA and counsel as to the tax implications on the entity sale.

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  • Nik Divakaruni
    OP
    Investor · Portland, OR · Member since 2016 · 19 posts · 3 votes
    7y
    Originally posted by @Basit Siddiqi:

    @Nik Divakaruni

    You are making the whole deal a lot more complicated just to provide the convenience of the buyer saving 5.5%. That is up-to you.

    I don't disagree - if it were easy, I'd do it.  But the 5.5% is north of $200k.  The easier way would be for the buyer to assume the full cost of that (it's split 2.75% each normally) and if he wants to do that, then he can take it.

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  • Eamonn McElroy
    Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
    7y

    @Nik Divakaruni

    "With that said, any ideas?"

    My original idea is as relevant now as yesterday.  Perhaps moreso with your new information.

    I encourage you to work with your attorney and CPA to ensure that you're both protected during the process and the sale is structured efficiently from a tax perspective.

    You seem to be giving some large concessions to what appears to be a third party buyer who approached you out of the blue.  I don't know if you realize it, but you're subsidizing his purchase.

    What's more, you're about to get into "financial bed" with him by co-owning the LLC. You need to speak with an attorney and a CPA.

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  • Nik Divakaruni
    OP
    Investor · Portland, OR · Member since 2016 · 19 posts · 3 votes
    7y

    Of course I'm speaking with my CPA and attorney, but there have been enough times where me (or a partner) have come up with an idea that neither of them did.  Crowdsourcing creative ideas isn't anything new.  

    Purely asking if someone has gone through this before, and if there are things I'm not thinking about.

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    7y
    Originally posted by @Nik Divakaruni:

    I've got a doozy here.  If anyone has a good solution for this, I will be hugely grateful.

    My wife and I are currently the owner of an LLC with 30 doors across 6 properties. We've been approached by a buyer to purchase the LLC from us (and subsequently all the assets) for a price, but he wants us, as sellers, to carry a loan. He's agreed to take over all costs, and will be entitled to all income from the properties during the time he's paying off the loan.

    If we move forward with this, I assume we would have to now file a K-1 as the LLC is no longer a pass-thru entity for my wife and me. The buyer will have the full P&L on his K-1.

    We still carry a note for the properties (one note, thankfully).  The buyer would, I assume, take out a loan to buy our business.  That loan will be between me and him.  

    Here's my question: Since the LLC has the existing note for the properties, and the interest the buyer would pay me would be personal, I would owe tax on the entire interest income from his loan, and since the interest expense on the existing note is through the LLC, I wouldn't be able to offset the two, right?

    Further, since the buyer would take over all costs and income, he would be able to write off the interest from his personal loan to me against the business (since it's being used for business purposes) AND would be able to write off the mortgage interest from the bank note (since it's in the LLC).

    Is there a solution here, where I can deduct the interest on the note through the LLC, from the interest income I'm making off his personal loan? Also - does someone potentially have a better way to structure this deal so I'm not getting hosed on the tax consequences of the interest income?

    Any advice would be greatly appreciated.  Thanks!

     We see what you are trying to do. 

    You are still going to get 11% profit loss via K-1. You will get the 11% of the deduction for the interest that LLC pays. If this is not the intention, you need to draft the operating agreement carefully.

    The sale of your portion the LLC would be personal and you would pay tax on the interest income and also on the gain that is realized on sale.

    Avoiding taxes on the interest income is hard to plan as there is not much that can be done. 

    If you could generate deductible loss from rentals or other side businesses, you could offset the interest income. 

    You have to remember that the interest income is extra income that you could have not earned that if you had not carried the note. So, don’t get too hung up but talk to your professional. 

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