I am going to be a “silent” partner in a LLC purchasing a complex worth $1,170,000. My contribution to the purchase is $65,000 (27% of down payment). I will have no responsibilty in the day to day tasks. This is a rehab project that will take up to 5 years to complete. My partner is guaranteed me a 6% fixed return payable at the end of the project with a 2% return on the profit. While under rehab my partner will be putting in an additional 200,000 to 500,000 into the project.
The question is, how should we handle the losses that are going to be accumulated over the years. Should I get a fixed amount of them, if so what amount would be fair?
If you are a 50% member, then, assuming partnership or S-corp taxation, you will take 50% of the profits and losses to your personal tax return. If you are a 2% member, then you take 2%.
Assuming corporate taxation, the corporation will pay tax on profits or carry losses forward. distributions after the property sells will be taxed again at your personal level.
The 2% “return on profit” confuses me. Profit IS the return. You will share in profits, losses and cash after the sale in proportion to your ownership share. If this is not what you want, then he should form up the LLC and just borrow money from you. Make the interest rate whatever makes you happy with the deal.
We are trying to figure out a way to structure it fairly, as the other partner will be handling all the day to day tasks, and investing substantially more money, and not charging any management fee. He is kind of bringing me a long for the “ride”, and giving me a guaranteed rate of return. I am doing a 1031 into the property, so just lending the money won’t work. The project is much larger in scope than I stated. I was just trying to simpify it by using smaller numbers.
Sounds like you are just making a loan, since you are guaranteed a fixed return at the end of the project. In the interim, you receive nothing until the project is sold.
What is not clear is the 2% of the profit. Is the 2% of the profit supposed to cover your guaranteed 6% return? Or, are you getting 6% return on your invested capital PLUS 2% of the profits. How much are the expected profits?
If your return is limited to just 6% over the next five years, you can do just as well with CDs or Treasury notes with virtually no risk. For example, E-Trade bank is offering 5.56% APY on a 1-year CD right now.