Partnership Buy-Out and Succession Planning

[Shawn Dones]

Context & Background:

Two business partners formed an LLC 20 years ago to own and manage rental properties. Last year, Partner A passed away, and their spouse (Partner A's Spouse) inherited their 50% ownership stake in the LLC. Partner B now wants to sell their 50% interest for $220,000 to Partner A’s two heirs (the Children). Meanwhile, Partner A’s Spouse is willing to transfer their 50% share to the Children but wants to retain a steady monthly income from the rental properties.

Key Facts:

• Each rental unit currently generates $550/month, but market rates suggest it could be raised to $850/month.
• The Children will buy Partner B’s 50% interest using a bank loan at 7% interest.
• After the purchase, the Children plan to pay a minimum of $1,500/month toward the loan while holding excess cash in a reserve account.
• There are 3 properties. A four unit apartment, a double wide mobile home, and a single wide mobile home. Partner B will get $220,000 + the single wide, while Partner A's heirs will get the apartment building and the double wide.
• They intend to sell one property ( the double wide mobile home ) and use the proceeds to either pay down the loan or reinvest in another rental property (possibly in another market).
• To defer capital gains tax, they plan to use a 1031 exchange for reinvestment.

Goals & Challenges:

1. Tax Efficiency – Structure the transfers and payments to minimize tax liabilities for Partner A’s Spouse and the Children.
2. Guaranteed Income for Partner A’s Spouse – Ensure a fixed monthly payment of $1,100/month while transferring ownership to the Children.
3. Long-Term Investment for the Children – Build a solid rental portfolio to support future financial growth.
4. Operating the LLC Under New Ownership – Ensure a smooth transition, including removing Partner A's Spouse and Partner B from the LLC structure.

Proposed Plan & Questions for Advice:

• Instead of outright gifting the 50% interest, the LLC will be restructured so that Partner A’s Spouse retains a Preferred Equity Stake that provides them $1,100/month in priority payments but gradually transfers ownership to the Children.
• Payments will only be made when rental income is sufficient (i.e., when rent increases to $850/unit).
• Partner A’s Spouse is willing to forgo payments in bad financial times but wants assurance that they won’t face any tax consequences on unpaid amounts.
• If Partner A’s Spouse passes away before full ownership transfer, the Children inherit the shares at a stepped-up basis (avoiding capital gains tax).

Questions:

1. How should the LLC Operating Agreement be structured to allow withholding payments when necessary without triggering tax or legal issues?
2. What’s the best way to document the transfer to ensure Partner A’s Spouse isn’t taxed on payments they don’t receive?
3. Are there better alternatives to achieve these goals while keeping tax efficiency and financial flexibility?

Would love input from anyone experienced in LLC structuring, real estate taxation, or succession planning. Thanks!