Additional capital contribution or loan to my LLC?

[Lisa Marie]

Hi, my husband and I are 2 members of an LLC (treated as a partnership). We decided that it's easier to buy a rental property using cash instead of trying to find a mortgage under the LLC name. We have some cash savings, but don't have enough. We are planning to take out a HELOC against our primary residence, and put that money into LLC. The question is: is it better to treat the infusion of HELOC money as additional capital contribution or as a loan?

To make it easier to understand, here are some numbers (not exact numbers in real world):

Husband and wife, each contributed $100k to LLC as capital contribution -- $200k in LLC to start. Needed $500k to buy a house, so we were $300k short. Took out a HELOC against primary residence to get $300k. To properly record the infusion, we can treat it as (1) Additional $150k capital contribution by each member, so the LLC capital is $500k; or (2) A loan of $300k by the members to the LLC.

Is there a difference in either approach, as it relates to tax or legal protection? The loan repayment is irrelevant to the Profit/Loss calculation of the LLC, right? So the only thing that impacts the P&L is the loan interest payment. However, since the LLC as a partnership is a pass-through, whatever interest payment made by the LLC (as an expense) is an income to the members, so it all washes out at the end, when everything is aggregated on the 1040, which will be married filing jointly.

I know every person who responds to this post will say "talk to a CPA".  I understand the value of a CPA, but part of the fun of being on BP forum is to educate myself and learn things, so that I don't have to rely on my CPA all the time, not to mention that he does charge me by the hour. 

[Ashish Acharya]

Originally posted by @Lisa Marie:

Hi, my husband and I are 2 members of an LLC (treated as a partnership). We decided that it's easier to buy a rental property using cash instead of trying to find a mortgage under the LLC name. We have some cash savings, but don't have enough. We are planning to take out a HELOC against our primary residence, and put that money into LLC. The question is: is it better to treat the infusion of HELOC money as additional capital contribution or as a loan?

To make it easier to understand, here are some numbers (not exact numbers in real world):

Husband and wife, each contributed $100k to LLC as capital contribution -- $200k in LLC to start. Needed $500k to buy a house, so we were $300k short. Took out a HELOC against primary residence to get $300k. To properly record the infusion, we can treat it as (1) Additional $150k capital contribution by each member, so the LLC capital is $500k; or (2) A loan of $300k by the members to the LLC.

Is there a difference in either approach, as it relates to tax or legal protection? The loan repayment is irrelevant to the Profit/Loss calculation of the LLC, right? So the only thing that impacts the P&L is the loan interest payment. However, since the LLC as a partnership is a pass-through, whatever interest payment made by the LLC (as an expense) is an income to the members, so it all washes out at the end, when everything is aggregated on the 1040, which will be married filing jointly.

I know every person who responds to this post will say "talk to a CPA".  I understand the value of a CPA, but part of the fun of being on BP forum is to educate myself and learn things, so that I don't have to rely on my CPA all the time, not to mention that he does charge me by the hour. 

Your understanding is correct. I would do capital contribution as it give you basis to deduct losses, if you are not limited otherwise.

If debt agreement is not drafted correctly (these kinds of debt rarely do), it will not give you basis to deduct your losses. 

These might be reclassed as equity rather than debt if all the obligations of debt payments are not followed. Too much admin work to track the debt obligation, get out 1099s for interest payments, if needed, and pay someone to draft it correctly to get the basis.