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    #1

    Gain on Sale b/w related parties

    I have a client who is a 3 member LLC involved in the flipping of houses. Or was flipping, now is more buying, improving, selling to a partner or the partner's spouse at a profit and then renting the property. The questions are a few:

    1`. The properties and their financing are in the individal partner;s names, as banks will not grant the LLC credit. The payments are made by the LLC for PITI, and deducted on the LLC return. This would seem to create a reporting issue (1098's in invidividuals names, the LLC taking the deduction) Any thoughts?

    2. Also, when the homes are "sold" it is done at a profit, Ex. Partner 1 buys the property for 100,000. The LLC puts in 15,000 in improvements, sells to partner 2 for 150,000. The LLC reports profit on the sale of 35,000. The LLC also pays all holding and closing costs on the property. Forget for a moment any percentage of completion issues surrounding homes held in inventory. Can the LLC recognize the gain on a related party transaction?

    Convoluted I know. Thanks all!
    "Congress has spoken to this issue through its audible silence."
    Anyone ever notice they beat the daylights out of the definition of a child, but they don't spend much time at all defining "parent"?
    Tags: None
    #2
    When you say "Partner 1 buys the property for 100,000" do you really intend to say the LLC buys the property using Partner 1's credit at the bank.

    And, also, when you write "sold" and put it in quotes, you've made everybody's ears prick up since - and this is a proven fact - whenever anybody puts something in quotes [usually words like "gift" or "loan" or "girlfriend"] it is a thin disguise for something the writer knows but is expecting the reader to look past, which the reader is then expected to guess at, so that the writer doesn't have to say something like "I suspect the partners are requiring each other to buy the houses at more than market value so that the LLC will look like it's making a profit."

    Is the sale at market value, yes or no?
    Last edited by les grans; 06-14-2008, 04:45 PM.

    Comment

      #3
      Nothing is in the LLC's name; not the title, or the financing. It is, for all legal purposes, owned by the partner. The "sold" is at appraised value, and no requirement is involved. It would appear to be an arm's length transaction, if the partners were not: 1. business partners, and 2. brothers and brother in law. Help at all?
      "Congress has spoken to this issue through its audible silence."
      Anyone ever notice they beat the daylights out of the definition of a child, but they don't spend much time at all defining "parent"?

      Comment

        #4
        I don't understand how the LLC can be anything more that a contractor doing home improvements and charging, in your example, $50,000 for the work being done.

        PITI should be paid and deducted on the property owner's return. Although PITI could be Construction PITI and needs to be capitalized on the owning partner. Partner 1 is the selling owner & partner 2 is the buying partner> Each has nothing to do with the LLC's income and expense.

        As I stated before, I see the LLC as nothing more than a home improvement contractor that has $15,000 of expenses with $50,000 of sales. The LLC has a profit of $35,000 to be split between is partners.
        This post is for discussion purposes only and should be verified with other sources before actual use.

        Many times I post additional info on the post, Click on "message board" for updated content.

        Comment

          #5
          thank heaven

          you think that way. I've been shouting that same thought from the rooftops for close to a year. Their current CPA (who only produces the tax returns, I'm in charge of all the accounting), either believes this is ok or has renered no opinion. This thing is a mess, and I am considering letting them go as a client. Best part is there are 2 LLC's, one to "own" the properties and one to improve them. They're one bank call away from insolvency anyway, maybe it will resolve itself.
          "Congress has spoken to this issue through its audible silence."
          Anyone ever notice they beat the daylights out of the definition of a child, but they don't spend much time at all defining "parent"?

          Comment

            #6
            Besides the tax issues, I also don't see how they even could have any liability protection since the houses are not titled in the name of LLC.

            I have another general question though. It happens quite frequently that small companies (Corporations and LLC's) don't get or don't get enough credit in the companies name, even though it should be the companies liability.

            Is there any good way to deal with this issue and have legitimate liabilities on the books? For example: Credit Card debt. An owner's/shareholder's loan would not work since the credit card is used frequently.

            Comment

              #7
              Gains Recognized

              Related party nonrecognition rules primarily apply to losses and not gains. A gain can be recognized and taxed.

              If they want the LLC to own title to these properties, why not make the loans with the LLC as debtors and the individual partners as guarantors? Doesn't make sense that the bank won't do this with guarantors that they are already otherwise loaning money to. You might not be getting the whole story...

              Comment

                #8
                Originally posted by Nashville View Post
                Related party nonrecognition rules primarily apply to losses and not gains. A gain can be recognized and taxed.

                If they want the LLC to own title to these properties, why not make the loans with the LLC as debtors and the individual partners as guarantors? Doesn't make sense that the bank won't do this with guarantors that they are already otherwise loaning money to. You might not be getting the whole story...
                Thanks for the clarification. I was about 99 percent on it only applying for losses, but I'm reviewing for the Audit section of the CPA and I guess my radar was on high alert. As for the whole story, you're probably right. It has been an adreneline inducing client so far.
                "Congress has spoken to this issue through its audible silence."
                Anyone ever notice they beat the daylights out of the definition of a child, but they don't spend much time at all defining "parent"?

                Comment

                  #9
                  Originally posted by AuditorTurnedGood View Post
                  Thanks for the clarification. I was about 99 percent on it only applying for losses, but I'm reviewing for the Audit section of the CPA and I guess my radar was on high alert. As for the whole story, you're probably right. It has been an adreneline inducing client so far.
                  What about below FMV gaines between related parties> There OK?
                  This post is for discussion purposes only and should be verified with other sources before actual use.

                  Many times I post additional info on the post, Click on "message board" for updated content.

                  Comment

                    #10
                    Yes to Both

                    Bob, below FMV are not only a gain, but also a gift if related parties.

                    Momma buys land for $50,000, is now worth an appraised value of $400 ,000.

                    Momma sells land to son for $200,000.

                    Momma has capital gains of $150,000 ($200K minus $50K).
                    Also has a gift valued at $200,000. ($400K minus $200K)

                    Comment

                      #11
                      Originally posted by Nashville View Post
                      Bob, below FMV are not only a gain, but also a gift if related parties.

                      Momma buys land for $50,000, is now worth an appraised value of $400 ,000.

                      Momma sells land to son for $200,000.

                      Momma has capital gains of $150,000 ($200K minus $50K).
                      Also has a gift valued at $200,000. ($400K minus $200K)
                      Yes, that was my point. A previous post said that it only relates to losses.
                      This post is for discussion purposes only and should be verified with other sources before actual use.

                      Many times I post additional info on the post, Click on "message board" for updated content.

                      Comment

                        #12
                        However, if the property is depreciable property in a "related party" buyer's hands, the gain to the seller will not be capital gain. It's in the code somewhere. Section 1239 maybe? Not even STCG, I think. Ordinary income. Maybe it affects this transaction, maybe not.

                        How about SE income on the gains from the houses bought, built, and sold??

                        How can the LLC be insolvent if it continues to sell things at a profit? Ho ho ho...

                        Comment

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