Personal Loan to LLC, reasonable idea?

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Topic Author
uncommonsense
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Joined: Mon Jul 08, 2024 7:43 pm

Personal Loan to LLC, reasonable idea?

Post by uncommonsense »

First of all, thank you all in advance for your sage advice. I’ve read many bogleheads threads and gained valuable insights over the last few years. Now, with my first post.

Background- My wife and I purchased a large parcel of land just over a year ago under our partnership LLC, for which we paid the mortgage deposit as a capital investment. Later, we had $ from timbering which has paid the monthly mortgage payment and other expenses.

Now, we are ready to build an investment home on the property. We are planning to use this as a short term rental. In looking into funding options, we came down to a few options. Essentially construction loan vs self funding seemed to be the best options. We have preliminarily chose the latter. To use a heloc in our personal home and some cash for funding. The plan is to draft a loan document in which the LLC pays us back with a fmv interest rate. Does this seem like a reasonable idea? If not, why?

As I understand it, we will be able to claim the interest as a business expense, but also have to claim it as income on the personal side. We use a pass through model currently. We didn’t love the construction loan secondary to several thousand in fees and a higher interest rate. Also, our builder wasn’t keen on additional red tape. In the longer term, if rates come down, we would be open to bundling the land/home into one mortgage.

Thank you again for your advice.

[Thread has been moved to the "Personal Finance" forum. Moderator Pops1860]
SubPar
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Re: Personal Loan to LLC, reasonable idea?

Post by SubPar »

Just make a capital contribution to the LLC and call it good. Why even bother going through the process of issuing a loan to the entity?
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neurosphere
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Re: Personal Loan to LLC, reasonable idea?

Post by neurosphere »

uncommonsense wrote: Mon Jul 08, 2024 8:11 pmThe plan is to draft a loan document in which the LLC pays us back with a fmv interest rate. Does this seem like a reasonable idea? If not, why?
Suppose you lend $100,000 at 5% to the LLC. In year one the LLC can deduct the $5000 in interest payments which will reduce the flowthrough taxable income to you by $5000. In year one, you'll receive $5000 in interest which will increase your taxable income by $5000. So you come out the same. No tax benefit.

But if you needed a HELOC to fund the LLC...is the personal interest you'll pay on the HELOC tax deductible? I don't think so but don't rely on me. In contrast, if you took out a loan in the name of the LLC, that interest could be tax deductible.

So if you lend to your LLC, the interest payments would go from LLC--->you--->HELOC. The net effect is no net tax penalty or tax benefit, right, if the HELOC interest is not tax deductible.

But if interest payments go from LLC--> LLC's bank, then the same interest is tax deductible by the LLC (meaning ultimately tax deductible to you).

All this assumes that you and your spouse are 50/50 on everything. It's a different thing if you are trying to segregate payments/liabilities between you. E.g. YOU make the loan to the partnership and not your spouse, and perhaps not filing jointly, etc.

All this is off the top of my head and while multitasking. I could be missing something big. :D
SubPar
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Re: Personal Loan to LLC, reasonable idea?

Post by SubPar »

uncommonsense wrote: Mon Jul 08, 2024 8:11 pm As I understand it, we will be able to claim the interest as a business expense, but also have to claim it as income on the personal side.
Interest expense incurred during the construction would need to be capitalized, not expensed. Separately, you'd also be subject to 163(j) limitations unless you make the Real Property Trade/Business election on your 1065, which I'm assuming you'd want to do.
JackoC
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Re: Personal Loan to LLC, reasonable idea?

Post by JackoC »

uncommonsense wrote: Mon Jul 08, 2024 8:11 pm
Background- My wife and I purchased a large parcel of land just over a year ago under our partnership LLC, for which we paid the mortgage deposit as a capital investment. Later, we had $ from timbering which has paid the monthly mortgage payment and other expenses.

Now, we are ready to build an investment home on the property. We are planning to use this as a short term rental. In looking into funding options, we came down to a few options. Essentially construction loan vs self funding seemed to be the best options. We have preliminarily chose the latter. To use a heloc in our personal home and some cash for funding. The plan is to draft a loan document in which the LLC pays us back with a fmv interest rate. Does this seem like a reasonable idea? If not, why?
Immediately previous post assumes LLC files a 1065. Does it, or is it a disregarded entity on your joint return because you're sole owners? If it's a disregarded entity it's simpler to just increase the capital of the LLC, not loan it money. If it files a 1065 return because of owners other than you/wife, it's probably simpler to loan it the money though not necessarily 100% simple as the previous post mentioned. But in that case increasing the capital would require redoing the ownership %'s of LLC owners other than you and wife to keep their $ interest constant, or possible commercial and/or tax complications if ownership shares remain the same without everyone contributing equally. If for some reason the LLC is a 1065 entity even though only you and wife are owners, are going to contribute equally or don't care if it's equal, then once again just increasing capital is simpler than a loan.
SubPar
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Re: Personal Loan to LLC, reasonable idea?

Post by SubPar »

JackoC wrote: Tue Jul 09, 2024 11:03 am
Immediately previous post assumes LLC files a 1065. Does it, or is it a disregarded entity on your joint return because you're sole owners? If it's a disregarded entity it's simpler to just increase the capital of the LLC, not loan it money. If it files a 1065 return because of owners other than you/wife, it's probably simpler to loan it the money though not necessarily 100% simple as the previous post mentioned. But in that case increasing the capital would require redoing the ownership %'s of LLC owners other than you and wife to keep their $ interest constant, or possible commercial and/or tax complications if ownership shares remain the same without everyone contributing equally. If for some reason the LLC is a 1065 entity even though only you and wife are owners, are going to contribute equally or don't care if it's equal, then once again just increasing capital is simpler than a loan.
OP literally called it a partnership in the first post -- I made no assumptions. They (OP and their spouse) would have to meet certain "joint venture" requirements for it to not be treated as such.

Also, unlike an S-Corp, there's no restriction on making non-pro rata distributions or having profits interests that diverge from capital interests in a partnership. You'd just need to ensure 704b partnership regs are adhered to.
EricGold
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Re: Personal Loan to LLC, reasonable idea?

Post by EricGold »

Co-mingling funds between an LLC and personal is a rats nest of problems. At the very least, your CPA will tear their hair out and charge you accordingly. If you are unlucky, an IRS audit will have a heyday.

The title of this thread is a good example of what to avoid. From the IRS POV, a private person may decide to invest in, or loan money to, a for profit business. If the arrangements do not clearly follow that paradigm then complications can get hairy.
Last edited by EricGold on Tue Jul 09, 2024 1:50 pm, edited 1 time in total.
spickups09
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Re: Personal Loan to LLC, reasonable idea?

Post by spickups09 »

EricGold wrote: Tue Jul 09, 2024 1:15 pm Co-mingling funds between an LLC and personal is a rats nest of problems. At the very least, your CPA will tear their hair out and charge you accordingly. If you are unlikely, an IRS audit will have a heyday.

The title of this thread is a good example of what to avoid. From the IRS POV, a private person may decide to invest in, or loan money to, a for profit business. If the arrangements do not clearly follow that paradigm then complications can get hairy.
If you document and book the loan from yourself as an individual to the LLC correctly, then that's not commingling. Commingling is when you transfer and spend money back and forth with no thought as to whose money it is or whose assets you are purchasing (yours or the LLCs). From the IRS's perspective, the LLC is a "for profit business".
Topic Author
uncommonsense
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Re: Personal Loan to LLC, reasonable idea?

Post by uncommonsense »

OP here- I agree, I don’t like the thought of commingling assets, and I was trying to keep a reasonable separation with the loan rather than just taking withdrawals at random.

Regarding the partnership, it is 50/50 with my spouse.
Topic Author
uncommonsense
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Re: Personal Loan to LLC, reasonable idea?

Post by uncommonsense »

neurosphere wrote: Tue Jul 09, 2024 10:14 am
uncommonsense wrote: Mon Jul 08, 2024 8:11 pmThe plan is to draft a loan document in which the LLC pays us back with a fmv interest rate. Does this seem like a reasonable idea? If not, why?
Suppose you lend $100,000 at 5% to the LLC. In year one the LLC can deduct the $5000 in interest payments which will reduce the flowthrough taxable income to you by $5000. In year one, you'll receive $5000 in interest which will increase your taxable income by $5000. So you come out the same. No tax benefit.

But if you needed a HELOC to fund the LLC...is the personal interest you'll pay on the HELOC tax deductible? I don't think so but don't rely on me. In contrast, if you took out a loan in the name of the LLC, that interest could be tax deductible.

So if you lend to your LLC, the interest payments would go from LLC--->you--->HELOC. The net effect is no net tax penalty or tax benefit, right, if the HELOC interest is not tax deductible.

But if interest payments go from LLC--> LLC's bank, then the same interest is tax deductible by the LLC (meaning ultimately tax deductible to you).

All this assumes that you and your spouse are 50/50 on everything. It's a different thing if you are trying to segregate payments/liabilities between you. E.g. YOU make the loan to the partnership and not your spouse, and perhaps not filing jointly, etc.

All this is off the top of my head and while multitasking. I could be missing something big. :D
Correct, the Heloc isn’t deductible in this situation from my understanding. It just didn’t sit well with me to personally pay interest (heloc) and the LLC not have any debt/interest payment. The main benefit would be the arbitrage of probably 2% between the heloc rate and the construction loan rate. Also, that I will be very personally motivated to get the heloc paid ASAP. I know it’s shifting sand from one bucket to the next, but I generally can accept business debt much better than personal debt.
Topic Author
uncommonsense
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Re: Personal Loan to LLC, reasonable idea?

Post by uncommonsense »

JackoC wrote: Tue Jul 09, 2024 11:03 am
uncommonsense wrote: Mon Jul 08, 2024 8:11 pm
Background- My wife and I purchased a large parcel of land just over a year ago under our partnership LLC, for which we paid the mortgage deposit as a capital investment. Later, we had $ from timbering which has paid the monthly mortgage payment and other expenses.

Now, we are ready to build an investment home on the property. We are planning to use this as a short term rental. In looking into funding options, we came down to a few options. Essentially construction loan vs self funding seemed to be the best options. We have preliminarily chose the latter. To use a heloc in our personal home and some cash for funding. The plan is to draft a loan document in which the LLC pays us back with a fmv interest rate. Does this seem like a reasonable idea? If not, why?
Immediately previous post assumes LLC files a 1065. Does it, or is it a disregarded entity on your joint return because you're sole owners? If it's a disregarded entity it's simpler to just increase the capital of the LLC, not loan it money. If it files a 1065 return because of owners other than you/wife, it's probably simpler to loan it the money though not necessarily 100% simple as the previous post mentioned. But in that case increasing the capital would require redoing the ownership %'s of LLC owners other than you and wife to keep their $ interest constant, or possible commercial and/or tax complications if ownership shares remain the same without everyone contributing equally. If for some reason the LLC is a 1065 entity even though only you and wife are owners, are going to contribute equally or don't care if it's equal, then once again just increasing capital is simpler than a loan.
OP- Sorry if my terminology was unclear. We do not file a 1065.
SubPar
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Re: Personal Loan to LLC, reasonable idea?

Post by SubPar »

uncommonsense wrote: Tue Jul 09, 2024 11:29 pm OP- Sorry if my terminology was unclear. We do not file a 1065.
For what it's worth, the default tax status of a multi-member LLC (irrespective of spousal ownership) is a partnership, meaning filing a 1065 is required. In order for that LLC to be disregarded, you and your spouse would need to meet the requirements of a qualified joint venture, which stipulates that you both surpass material participation thresholds under Pub. 925. If that is the case, as JackoC correctly pointed out, you'd each take a pro rata share of LLC activity on your personal return.
JackoC
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Re: Personal Loan to LLC, reasonable idea?

Post by JackoC »

EricGold wrote: Tue Jul 09, 2024 1:15 pm Co-mingling funds between an LLC and personal is a rats nest of problems. At the very least, your CPA will tear their hair out and charge you accordingly. If you are unlucky, an IRS audit will have a heyday.

The title of this thread is a good example of what to avoid. From the IRS POV, a private person may decide to invest in, or loan money to, a for profit business. If the arrangements do not clearly follow that paradigm then complications can get hairy.
Again, key is 1065 entity or disregarded entity (words like 'partnership' or 'LLC' should ideally be used exactly but key practical distinction is 1065 or not). OP confirmed: not 1065, so must be disregarded entity on Sch C of 1040. In which case there is no commingling issue on the capital side of things. If your disregarded entity real estate LLC needs capital to develop a new property, just give it the money, nothing to report on your 1040. There is no tax reason to structure it as a loan. On audit the IRS will have no interest in how/why you transferred money to yourself, what it is from their POV for a disregarded entity. Separate from tax it's still a good idea to keep full 'books' on a disregarded entity including capital accounts. A 3rd party lender (if you ever go that way) will want to see a balance sheet for the entity, and it's a useful tool for your own analysis.

But I agree it's strictly necessary to keep good records on the *operating* side of a disregarded entity for tax purposes, especially expenses. For example if the disregarded LLC hires a handyman for a rental property that's as a rule deductible on Sch. C. If you do it for your house it's not deducible as a rule. If in the first case you keep poor LLC records and can't clearly show the bill was for the LLC/rental property: potential audit problem listing the expense on Sch. C. Whereas if the LLC collects rent from a property the ambiguity is less, that's taxable income, only a problem if you're so sloppy you accidentally underreport it (forum standard= no deliberate tax evasion ever) and an auditor finds it. For disregarded entities and tax: Income is income, expenses should be well documented to avoid confusion between Sch C business and personal, capital transactions like OP's don't need to be reported. Though it's better to keep good records on everything than not to.
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