How to partner with an existing property owner?

Question

Hi friends, looking for a creative solution here as I've never heard of this being done. Apologies in advance for my lack of clear articulation.

I would like to come in as a partner on a property already owned by a colleague. This is a small multifamily that he is reluctantly selling to free up funds to make improvements on his primary residence. He is not looking to 1031, so capital gains will be factor, and he would rather sell than refinance into more debt and less cashflow. More importantly, selling means he no longer owns a cash-flowing asset. I proposed coming on as a partner in the property. We would boost the value through AirBnB-ing 1-2 units, increasing rents, and also using the detached garage for our own purposes -- storage, workshop, etc. He loves the idea, as we would both benefit from long-term appreciation, cash flow, and using the property as space for our businesses.

Question #1: How would I come in as a partner since he already owns the house? We would form an LLC to hold the property, then ideally refinance into the LLC. A sale to the LLC would trigger capital gains and increased property taxes, so that would defeat the purpose altogether.

Question #2: How do I figure out how much cash I should put in the deal to make it 50/50 ownership and profit-sharing moving forward? His current mortgage is 40% LTV, so a refinance would automatically put cash in his pocket. Figuring out how much I need to bring is what I can't wrap my head around.

Thanks for your creative thoughts.

- Tim

Drew Sygit · Answer

@Timothy Smith not sure how you're going to get around a taxable event.

If he sells you half the property, that's probably a taxable event. You'd want this anyways, to adjust the cost basis of your half. Otherwise, you'd be stuck dealing with capital gains caluclated off his cost basis.

Speak with a tax professional familiar with real estate.

Nate Sanow · Answer

I think you could buy a share of the LLC.  Definitely have an attorney involved there if you do.

Kathy Henley · Answer

@Timothy Smith Renting two of the units as short term rentals increases the income, not the value. You will keep what is left, after paying the bills. It's a business.

You might capitalize the business 50/50. You might agree to split the sale of the asset 50 /50, when it sells in the future. The capitalization of the LLC will be memorialized in the company's operating agreement. Also iron out how decisions will be made, how cash draws will be made. Let a lawyer and CPA review the OA.

The operating cash flow might be split with different percentages, according to the management roles. Describe each partners roles and responsibilities during the life of the business. Who is going to clean the place and manage the bookings? Write it down. Who will respond to  the repair requests, renew the leases, market the property and cut the grass? Who does the bookkeeping? Write it down. This will become the management agreement of the company. When will the cashflow be disbursed? Agree to something. It can be amended anytime, if both partners agree..

Ryan O'Mara · Answer

@Timothy Smith - You just need to create the new LLC and have an operating agreement that clearly lists you and this partner as owners and the % of ownership you each hold.  Then when you refinance the property, you do it under the new LLC and the property gets titled in that new entity.

The refi process will require an appraisal which will give you the evaluation you need to then figure out between your partner what, if any cash, you need to put into the partnership.  Even without the appraisal, you should be able to get a good idea of what the market value is and work off that.

William Sing · Answer

Hey Timothy! This sounds like you have a lot of options.

Sounds like seller financing might be a good option for you if you want to take over the property eventually. You could set it up so you take over the property management-wise and then provide a stable income to the seller. You can then set up a balloon payment 5-10 years down the line (where you and the seller have the option to sell the property entirely and move to conventional financing). This would create a win-win for you two and delay a lot of capital gains tax until you buy it outright.

If you still want to have them on as a partner, talk to an attorney about creating an operating agreement. Each state is a bit different in how they have these rules play out and they can give you pointers on what needs to be included. If you do refinance it, check with a lender to make sure they would be able to do that. A lot of times you are going to run into issues with refinancing into an LLC if it is in a personal name. Usually, you can refinance in the personal name (of the seller in this case) and then put it into an LLC. Just know that this might trigger a due on sales clause.

As for your second question. This is completely subjective. I know this isn't super helpful, but a 50/50 might work for now you can always add clauses into the operating agreement to see if things need to be changed. I'd take a look at how many hours monthly/annually you'd need to put into making this agreement work and double it. Humans are notorious for underestimating our abilities. You can then do a per hour to see how much you'd be putting in "sweat equity wise". You could bring a larger amount down to increase your ownership/profit share from it but that is a question of how much you want to put in and get out of it.

Hope this helps!

How to partner with an existing property owner?

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