All Forum Posts by: James Hedgecock

Steve, NSDREI is a great north county group with monthly meetings and they promote several other meetings on their site. All the best!

@Basit Siddiqi - ok, then I am still missing something! I was told I need basis in the project in order to take the depreciation? I guess it could be assigned to me, but how to use it? If you have any summary or links to an explanation on this I would appreciate it!

@Basit Siddiqi thanks! Yep, I think I've got this figured out at this point and better understand the difference between equity ownership and profit sharing % in the LLC agreement. If you want the equity and the depreciation that comes with equity ownership you have to either put in the capital or at some point figure out how to satisfactorily take out your equity partners and replace them with your own capital or debt. Always learning!

@Dan Dietz - I wish it was that simple... But assignment of debt can create equity ownership and basis for depreciation, in general. How it applies to your deal, and how much debt as a percentage of other capital and debt, determines your percentage of equity ownership. You may want that to be different than your percentage of future distributions. Each of these can be outlined separately in your operating agreement. (that's my understanding from researching this topic with multiple CPAs thus far, but I am no expert!)

@Ashish Acharya, thank you for the reply. I agree that if you are being given a % of equity that has value for services rendered, it is a taxable event. I think the best way to move forward is with the profit sharing % interest so that I am only taxed on those liquid distributions as they happen.

@Joe Splitrock, thank you, and I agree that in some cases loan(s) from partners instead of equity would make sense. Or a buyout refinance between the construction phase and the permanent financing phase. I believe @Matt Faircloth covers some of this in his BP book, Raising Private Capital. In this case the equity partners are needed to sign personally on the loans, so they have to stay in as equity. But I believe this is a solution to create equity ownership and basis in the deal for a non-cash partner. 

BP Community - I know this is a sticky legal/tax topic that is near impossible to solve in the forums and it requires a custom CPA solution for each situation. However, I am very surprised by the amount of BP content in podcasts, books, and online that uses the word "equity" when talking about "sweat equity" partners and capital partners. Countless situations refer to the Non-cash partner as sharing equity % with capital partners, whether in partnerships, LLCs, syndiactions, LPs, etc. This is in contrast to everything I am learning, which is that the money usually owns 100% of the equity and the non-cash partner, general partner, whatever the name is, owns a profit sharing percentage only. These situations are often short term deals, that when made liquid, provide profits to all and are then taxed more easily. But on a long term buy and hold deal, this is a big issue. I wish it was better addressed via a new BP book or an in-depth podcast. Maybe soon!

All comments are welcome as I hope this thread helps others that might struggle with this concept and otherwise get themselves into trouble with the tax implications.

I'm trying to structure a California LLC as the non-cash partner. My partners are bringing the cash to the deal. We are building ground-up condos and planning to hold them for rent long term. I found the property and assembled the team, and I will be the managing member of the LLC - and I have negotiated a % of the deal in return. My CPA is telling me that if I take a percentage of equity ownership, that is a taxable event and I will owe taxes on my % of the total capital raised as outlined in the operating agreement (on day 1 before we have built anything!). This is my first partnership multifamily deal after purchasing and renting my own properties, and I'm a bit lost on this topic.

My goal is to have equity ownership, take advantage of depreciation, and hold the property in the LLC long term, while collecting distributions and paying applicable taxes on those distributions.

My intention was to assign % ownership when the entity value was $0, like can be done when founding a company prior to incorporation. Thus no taxable event. Is this possible in a real estate deal, or am I forced to only be a profit sharing member of the LLC, taking distributions but not holding equity?

With so many partnership deals and syndications out there, there must be some proven strategies!

@Christina Labowicz my apologies for missing your original post/question, let us know how you are doing and how to help. It's been a crazy year, but good for most investors.

@Ben McMahon, it looks like @Dan H. has you covered. The upside to the low appraised value of ADUs for cashflow buyers is that a SFR/ADU 2 unit rents for as much as an equivalent duplex, but it costs less. So if you are buy and hold this is one of the best returns available. If you want to sell, then... - why would you sell a great cash-flowing asset...?! I think this is an innefficiency in the market. They should appraise a little less, but not as much as they do.

@Tyler Hayes sorry for Dan and I diving deep on your thread, hopefully it helps!

@Dan H. sounds like we better grab a coffee once we are allowed to do that sort of thing again. My first 2 SFRs I did 25% down and added a little in rehab, easier in 2012 and 2017 when I bought those. My goal with #3 in 2019 was to borrow, pay cash, rehab, try to refi out and end up with the least amount of cash in the deal, lower cash flow. So, playing with the variables. If my numbers hold I should have about 13% of the new appraised value in the deal, pay off the original loan borrowed to pay cash, and lock into a 30 year fixed with some cashflow. Luckily I have some room in the deal from buying well to weather the current situation as well as built in flexibility with my private lender to extend the interest only period before I finish renovation and refi. That was the only way I bought that deal in this market.

The cashflow of rent vs cost on SFR/ADU is just so much better than duplexes. I see tons of opportunities there, and if you can add the junior ADU it really makes sense.

ADU buildout makes sense as there are way more SFRs with room for an ADU than ones with an existing ADU. I have thought about it a great deal, just need enough volume to optimize them. Several companies will do well delivering prefab ADUs at the right price.

This market is going to provide new opportunities. Yesterday's market was pretty picked over. Let's stay sharp and take advantage!

@Dan H.

Dan, I'll try to keep this transparent as everyone likes to interpret these definitions differently, so at least if I define it differently you can see where the numbers come from. Happy to discuss off-line.

My best rule of thumb I use, which seems to hold up in my niche, is that I want the projected monthly rent to be 0.7% of the purchase price plus rehab cost. EX: bought the house in 2019 for $475k. Rehab $110k (roof and foundation done while current tenant still paying, back detached ADU was a quick $10k and then rented quickly, so cashflowing well during this process). So total house cost $585k. Rents will be $2800 for the main 4/2 house, $1700 for the 1/1 detached ADU (currently $2050 for the 4/2, already $1700 for the ADU, will rehab front house over 2 months at end of current lease - and coronavirus - to then increase rent). So total future rent $4500. 4500/585000= about 0.77%.

This rule for me rolls up everything you asked into a simple tool to allow me to easily analyze most deals in my area. Other people will have other numbers that work for them. Most people I know do more volume and accept thinner deals than this.

In my detailed calcs I factor in 5% vacancy (never had anything over 1% since 2012, but maybe soon). Then expense for cashflow:

- Taxes, estimated expenses, insurance. Expenses are avg monthly maintenance and cap ex. I use 0.7% of purchase price per year for cap ex., and my experience on the maintenance is that it runs about $400/mo for each property.

- Mortgage payment

When I run the details I usually come out near 5% cashflow plus principle payment that will give me a starting annual net worth return of 8-10% without counting appreciation.

I run a separate checking account and separate Quickbook file for each of the 3 properties. Hopefully that helps you or others, feel like I am on a bit of a tangent on this thread!

These deals have become increasingly hard to find and the current crisis will undoubtedly change things. The 2019 property was unique (every deal is) in that the seller had to sell to complete a 1031 quickly, the property was not bankable (private interest only loan converting to a conventional after all rehab), and needed serious work. The other ones bought in previous years were easier. As you can tell this one still isn't done, but it is still cashflowing as I work through it. Maybe we will have easier deals in the future!