How to co-own when she buys into my existing property?

[Dana Powell]

Hello BP--I own a SFH rental property valued at $800K with a mortgage of $277K on a 1-yr ARMcurrently at 5.125% amortized over 25 years with a $3600/month gross rent.

A friend and I are considering co-ownership: she would cash out her annuity for $400K for a 50% share of my property and receive half of the net rental income, minus $200 which I would retain for managing property. We would re-deed the property as Joint Tenants in common (vs LLC because after the current tenant leaves in August, we would move-in and rent out the basement and would want to obtain an owner-occupied cash out refi loan to pay off /down our respective debt. Not interested in additional real estate investment).

How would the IRS view the $400K I would receive from her? Would it be taxed as ordinary income (yikes!)? I do have an LLC for my B&B business--it doesn't own property ; if she invests in that LLC would the $400K be taxed? What if we created a new LLC and she invested that cash? Also, I may use the $400k to pay down a $1.2 million principle on my B&B instead of paying off the $277K mortgage (with my friend's approval and with re-deeding this SFHrental in both our names). What is the best way for us to co-own this property paid for by her cash and my equity?