BRRRR - Capital Gains on Excess Funds Borrowed Over Basis

[Owen Dashner]

I'd like feedback on a BRRRR scenario from folks who are in the know about taxes related to capital gains. Let's say you buy a property for cash in an LLC, taxed as a partnership (you have a 50/50 partner). It is bought from an extremely motivated seller, so it has a bunch of equity, and is already rented. The purchase price is $85K, the house needs a $10K roof replacement, so your all-in cost basis on the property is $95K. You approach a lender that does an internal valuation (appraisal) on the property, and determines the value to be $140K. This lender will loan up to 85% of the value, so $119K. Assuming the property would still cashflow, if you did the cash out refi and deposited the $119K, you would have $24K of excess cash beyond the basis of the property.

After discussing this scenario with 2 different CPA's, the feedback I have received indicates that if that excess $24K was distributed to the LLC partners for personal use, it would create a taxable capital gain event because it exceeded the amount of basis in the property. But, if the $24K was left in the LLC account and used to pay the operating expenses, it would not necessarily be taxable as a capital gain until you sold the property. Is this correct? Is there a way to capture the equity and be able to use it (other than leaving it in the LLC account)?

Hopefully the above scenario makes sense.  I'd love some feedback from other tax-savvy investors on this.