LLC capitalization question

[Margaret CPA in OH]

Clients formed LLC a few years ago to purchase, rehab and sell properties for low income housing. They are really "do good" folks with 6 foster children, all minorities and mostly health challenged. He is a physician, she is a nurse practioner. The first 2 houses they completed just when the market decline began and decided to rent until things turned around. This third house was bought in late 2010, rehabbed and sold sometime early in 2011. I am working on extended 2010 returns. The buyers are son and daughter in law (does that matter?). I think all expenses are capitalized as this third house would be inventory, wouldn't it? Because the business purpose is to rehab and sell, I think the houses wouldn't be investment properties, or would they?

The second question relates to member infusions of cash to complete rehabbing because rental income is insufficient for the entity. Members want these to be loans, not capital contributions. The first couple of times they were significant amounts, in the multiple thousands, and at least one was repaid when they were able to get a Line of Credit on one house. But what about the $200, $500, etc. smaller amounts?

Thanks for comments and steering me on the right course.

[OldJack]

>>house would be inventory, wouldn't it?<<

Maybe...maybe not! Why not ask the client if they purchased as an investment? Its really not your call.

>>The second question... <<

You failed to say how the LLC is to be taxed.

[Margaret CPA in OH]

OldJack, the house purchases are intended to be for rehabbing and resale according to the LLC purpose. So I think it would be inventory but just wanted to check with others. They really don't want to hold these for investment purposes and didn't yet sell the other two only because they would have lost money. On this property they knew it would have a profit.

The LLC is deemed a partnership, the default. As I wrote, the early cash infusions were in large amounts and were expected to be repaid fairly quickly when the properties sold. The market wasn't so friendly. I'm just wondering about these smaller amounts several times over the course of the year when utilities or insurance is due and rental income is insufficient. It just seems painful to treat each as a separate loan with fmr interest, etc.

Thanks again for nudging in the right direction!

[OldJack]

>>OldJack, the house purchases are intended to be for rehabbing and resale according to the LLC purpose<<

Rehab and sale does NOT, in itself, mean it has to be inventory rather than investment. Of course the IRS would not argue with you calling it inventory.. unless it was sold at a loss.

>> It just seems painful to treat each as a separate loan with fmr interest, etc.<<

Then why not consider them temp demand interest free notes and consolidate the loans before the end of the year with interest at the applicable federal rate (AFR).

[Margaret CPA in OH]

Thanks for futher responses. The biggest difference between investment and inventory as you know is ordinary or capital treatment. I am of the opinion that this is ordinary but will reconfirm with the clients. However, capital assets are not inventory held mainly for sale to customers in a trade or business or depreciable property used in a trade or business or real estate used in a trade or business or as rental property.

The note treatment is one that I have done with some S-corp clients and was inclined to show repayments against the money that the LLC owes them (unpaid interest from prior years which has been reported on their personal returns). Sigh... retirement looks better all the time.

Thanks again, OldJack. So glad you are on the board this evening!