All Forum Posts by: Peter Myers

Most investors, unless they are friends or family, are not going to take 6% or 7% on this type of leverage.  They will either want an equity spiff at the refi, a conversion privilege, or a higher yield.  Maybe Dad doesn't care, but the typical investor does.  I concur that in a flat market, you are doing nothing but getting an education, which may be valuable if you are new to deals.  In an appreciating market, where you are rehabbing, it makes sense to lever like this.  But step one is to decide what the tactical goal is here: security (hoard your cash, use OPM); return (are you getting more on your cash than the loan rate?); appreciation (building equity/net worth for future deals, growth, etc. - but accept the risk); or education and contacts (back to security).  Does the tactical goal fit your strategic goal (retire at 45, syndicate multi-family apartments, develop shopping centers, whatever).  I see a lot of questions at the granular level here, and until you've done the necessary work on yourself (what do I want out of this life?), it's hard to frame the questions you have.

The LLC requires Articles of Organization. These are filed with the CA Secty of State. In addition, you will need to have an Operating Agreement among the members. Typically, you would have the Operating Agreement prepared to reflect your deal, as opposed to ordering one "out of a box" that may not reflect the actual arrangement among the members of the LLC. Yes, they are cheap to purchase, but very expensive when you consider that if they do not reflect the agreement, you will have lawyers fighting over what the canned Operating Agreement means (or should have said, or didn't consider, etc.), and needless to say, that is more expensive than getting the Operating Agreement right in the first place. But I am used to this discussion and at least half of the people who ask me, as a lawyer, about this question and ultimately choose to use some out-of-the-box solution. I don't sell; I just provide information. Sometimes it works and sometimes it does not.

A "put" right is a right to sell.  A "call right" is a right to buy.  They are both options.  With a buy-sell agreement inside an Operating Agreement, and this is very basic (I teach 3-hour classes to lawyers on buy-sell agreements) you can use the put right to determine what the voluntarily departing member would get paid if (s)he wants out.  You can use a call right to determine what the rest of the owners pay to the involuntarily (kicked-out) departing member who, say, stole from the bank account, or didn't post their capital when it was called by the manager (if you had a deficit restoration obligation, for example), or didn't show up to replace the toilets (at the granular level).

I may do a standalone piece/article/chapter for some of the forums I post to on doing buy-sells (either inside operating agreements or as standalone agreements - they can be done either way).  A form for a document that is titled "Operating Agreement" is not hard to find online.  All the advice and information that go along with the document, most of which has to be adjusted to the budget of the entity (in most instances, you don't spend $15K negotiating an operating agreement for a $50K business), is the valuable part.  (Like any legal document).  There are simple guidelines that most 12th graders can follow, and then there are some not-so-simple concepts that require a few years of experience in the business and some training in tax, finance and accounting to understand (the latter of which you probably won't need for the four-plex).  HTH. 

@Ori Skloot: If you buy cash and refi the LLC, then take a look at PeerStreet lending or google their competitiors. Again, watch out for that Operating Agreement. Consider a put right with an installment sale at lender's loan rate + 2.0% for any member who wants out.

What kind of real estate? Landlord tenant?  Construction?  Land use? Purchase and sale dispute?  Boundary dispute?  Real estate law is subspecialized.  I use Dave Stein out of Oakland. @Naseer Khan: I would like to meet you some time.  I am a tax and trusts lawyer in San Francisco but live in Alameda.

The concern I would have with conventional financing would be defrauding the lender (which is a crime) if the tenants in common are actually mere nominees of the LLC as the true owner. If the lender finds out of the transfer to the LLC, they could trigger the due on sale clause. Both of the above are rare, but the consequences are pretty ugly.

Assuming you and your fellow owners can stomach those risks, be careful. LLCs can be messy, because it is extremely rare in non-family situations that everyone will think the exact same way indefinitely and get along. There needs to be clear structure that matches the relative influence of each partner (member in an LLC) in the investment. If one person is making the decisions and the others are passive, it may work (consider a limited partnership in that instance).

As far as real banks, just pick up the phone and dial for dollars. Mechanics Bank, Patelco Credit Union, Bank of the West - I'd start with those three. 

Find a mentor.  Live frugally as Derek says. Don't just learn real estate; learn accounting and finance if they offer anything like that in high school.  Take math classes.  Go to college and take these electives:  accounting, business law, architecture, interior design, land-use planning, project management, landlord-tenant law, finance, civil engineering, economics, and securities regulation.  Work summers for a small general contractor (plumbing, electricity, cabling, roofing, appliance installation and repair).  Learn how to sweat pipes.  Think big.  Figure out what do you like:  office buildings, warehouses, retail, restaurants, residential, multi-unit, industrial, right-of-way, etc.  Is your goal to develop transmission lines?  Ports?  Airports?  Freeways?  Or just houses? The bigger you can think the further you will go.

Where are you going in life?  is real estate a hobby?  are you looking for safety and security, or is this "first" investment the first of many in a career that will eventually include multifamily and commercial?  I think your focus is too tactical and not strategic enough.  If your goal is beyond a house flip or two, then refinance the primary.  If you just want to flip a house, or maybe two, hobby-style, then sit it out until a seller comes along willing to take your conventionally financed offer.  

I am a bored tax lawyer and occasionally visit this site.  The tax and legal advice above is generally wrong, but not in a mean-spirited way.

This is information only and not legal advice.  You must consult your own tax adviser and lawyer to get proper advice.

Each donor-donee has a $14K annual gifting exemption.  Its not a limt, its just an amount that is exempt from the gift tax.  So if your parents each give you and your spouse $14K, then you get $56K in exempt gifting.  Any amount above that reduces their lifetime exclusion ($5.45 million per person) by the amount of the excess.

The gift (of any amount) is not income to you nor a deduction to them. You cannot gift income under the assignment-of-income doctrine, so don't even go there.

Gifting to an LLC is not exempt. The donor reduces his lifetime exclusion amount by the amount of the gift.

LLC's are used primarily for asset-protection and continuity of management purposes. They are not generally used by laymen for tax reduction, although high-end planners will use them for that purpose in different scenarios way beyond the scope of this post.

I generally like your idea, not necessarily because it makes much money, but because it is a fairly low risk way to enter the business.  If I were advising your parents, I would have you choose one of the two properties to purchase.  The point is that the education you get from jumping in is going to be far more valuable than the few dollars this investment might accidentally yield to you or to them.  Keep a journal of your mistakes, especially, and your occasional wins (which are likely to be occasional at best, given that this is your first investment).  Report to a mentor at least monthly.  Take a class or independently learn how to read a financial statement and how to prepare a tax return (and Schedule E in particular).

Good luck.

In general, and this is not legal or tax advice, just information - while there are exceptions, you rarely want to buy any sort of depreciable property as a corporation.  This creates problems down the road when someone wants to sell their interest or dies.  Under US Tax law, C corporation are not "pass through" entities - meaning there are 2 layers of tax - one layer at the entity level (the corporate tax) and one layer at the shareholder level (the tax on dividends).  While you could choose an "S" corporation and have pass-through tax, there are a number of problems with this: (1) you are possibly creating character mis-matches of ordinary income and passive losses, depending upon the level of management activity you have; (2) a buyer is not generally likely to want to purchase your fractional interest in stock - they will insist on a discount or worse, an asset sale.  The asset sale will trap the capital gain inside the S corp.  While it could be distributed, it will come out as gain as well; (3) there is no "step up" in basis at the death of the shareholder, except as to the basis in the S corporation stock (which is not depreciable) - thus, the surviving spouse can re-set the basis and re-depreciate the property (or sell it and recognize no gain).

Most investors I know either use trusts (a discussion of trusts is beyond the scope of your question), or LLC's taxed as partnerships when investing in depreciable property. In this instance, you are creating an entity (an LLC) but still obtaining one layer of tax (through the pass-through treatment of gains, losses, income and credit). We literally can spend weeks evaluating what type of entity to deploy for a particular investor's purchase. It is rare that a C corporation pencils out when all of the planning factors are considered.

hth,

Peter S. Myers