Multiple LLC's rent, remodel, income questions

[mblatour]

I hope I can make sense as I ask these questions, so bear with me. A multi-member LLC (we'll call it Abe's Diner) filing as partnerships made a decision made to purchase a new building and in doing so, started up a second LLC (we'll call it Bill's Properties) to make the purchase, handle the payments, expenses, etc., leaving Abe's Diner as the renter of the building. Bill's Properties did not have the funds to get started, therefore Abe's Diner needed to cover the initial costs such as filing fees, closing costs, earnest money, etc. Abe's Diner has also begun making a monthly rent payment to Bill's Properties to cover rent, utilities, taxes, etc.

There was a "hitch" if you will, in the purchase agreement stating that $25,000 must be placed in an realtor's escrow account to be used as improvements to the building, in lieu of a down payment. Abe's Diner cut the check for the account and has since spent $25,000 and much more towards remodeling the building; and has also since been reimbursed these funds from the escrow account. The $25,000 was paid by Abe's in 2015, but reimbursed to Abe's in 2016. Bill's Properties wants to be responsible for all of the remodeling expenses on the building they own, so as to show the future equity in the building. BUT, Abe's Diner was the one whom paid out the $25,000 escrow fund, and also continued to pay the $25,000 in remodeling expenses in order to be reimbursed back the $25,000 escrow funds. As of right now, Bill's Properties has not contributed any funds towards the remodeling, but wants to someone take ownership for those funds.

What is the best route to take tax-wise here? Bill's Properties does not have the funds to continue to do the remodeling and therefore would need to create an ongoing "Note" owed to Abe's for the previous $25,000 spent and any future funds being spent on the remodel; agreed? The monthly rent paid by Abe's to Bill's covers the regular monthly expenses with not much to spare. Abe's has the funds to do the remodeling whereas Bill's does not.

Thoughts are very much welcomed! Thank you!

[kathyc2]

It sounds like there are several things going on here. Are all the members of Abe's all members in Bill's in the same proportion? Who are you the preparer for? Both LLC's and one member? Both LLC's and all members? Was the reason for Bill's being formed for legal protection? Does the lease agreement speak to which party is responsible for improvements? Since there are several parties involved you may want to be careful before giving any advise as a better tax treatment for one member may have an adverse effect on another member.

[mblatour]

It sounds like there are several things going on here. Are all the members of Abe's all members in Bill's in the same proportion? Who are you the preparer for? Both LLC's and one member? Both LLC's and all members? Was the reason for Bill's being formed for legal protection? Does the lease agreement speak to which party is responsible for improvements? Since there are several parties involved you may want to be careful before giving any advise as a better tax treatment for one member may have an adverse effect on another member.

Thanks for your response and to answer your questions in order.... There are two members in Abe's at 51%/49%. Those same two members in Bill's are 50/50. They are husband and wife. I'm the preparer for both in this case. They formed the second LLC as a property's management LLC with the plan to own this building, then if eventually Abe's Diner decides some day they want to move on, expand elsewhere, etc., they are free to go, and Bill's property management company is allowed to rent/lease out the building to someone else instead. According to the client's they never really set in stone which LLC would handle the improvements, but are asking my advice now if I see a better option to having the property management taking on the improvements therefore increasing it's equity in the building, rather than the diner doing the improvements in a building they do not own (but can deduct as expenses against their profits as a business).

My original thought was to stick with the diner paying for the improvements as the tenant. Every tenant will want to make changes, it's typical. But then again, I do see some weight to wanting to increase value to the building as well. ????

In the end, it all trickles down onto this one couple, two LLC partnership returns, and one personal tax return.

[kathyc2]

Since 15 is done, I would show a note receivable on Abe's books and a note payable on Bill's books. Bill's would then depreciate the improvements. Then in 16 have Abe's make shareholder disbursements to member for the amount of the note. Then members deposit in Bill's and make a loan to Bill's and then Bill's pays Abe's. It sounds like a lot of paperwork, but will preserve the separate legal entity transactions. Since the building is now improved and Bill's paid for it, it would be reasonable to adjust rent accordingly. Higher rent means less income on Abe's books and therefore less SE tax. Of course you should advise them to document it all in operating agreements in an effort to preserve the separate legal protections of Bill's.

[mblatour]

Now you've got my gears turning.....that's definitely another way to look at it. It definitely makes sense to raise rent accordingly for an improved property. I appreciate your response and will ponder this mess a bit longer. Thank you!