Question
I am involved in a real estate deal with a partner. We are getting ready to sell the property and are in disagreement about how to calculate profit. This is the story:
Partner 1 put 10% down and the mortgage is in his name
Partner 2 put nothing down but paid everything 50/50 from the day of purchase (about 6 yrs ago)
They agreed that original 10% down represented Partner 1 having 10% more interest in the property. This is documented in the co-tenancy agreement.
They were both living in the house and put a co-tenancy agreement in place along with a quit claim deed to partner 2 for 45% interest in the house.
About 2 years ago, they decided to rent the house rather than continue living there together. They started an LLC to protect personal assets and therefore did a quit claim deed (both of them deeding the property to the LLC). They also have an operating agreement for the LLC which denotes the 45/55 split in ownership as capital contributions.
They now want to sell the property. In one scenario, it is a basic sell price minus debt divided by % of interest calculation:
Today's Est. Selling Price 550,000
Est. Closing Costs (33,000)
Mortgage pay off balance (270,000)
Net Profit 247,000
Partner 1 (55%) 135,850
Partner 2 (45%) 111,150
In the second scenario, partner 1 wants to calculate appreciation (sell price - purchase price) with a 45/55 split and then look at equity (purchase price - debt still owed) in terms of $ contributed.
Appreciation:
Today's Est. Selling Price 550,000
Original Purchase Price 400,000
Est. Gain on Sale 150,000
Est. Closing Costs (33,000)
Net Proceeds 117,000
Partner 1 55% Est. gain on sale 82,500
Partner 1 55% Est. closing costs (18,150)
Partner 1 55% net proceeds 64,350
Partner 2 45% Est. gain on sale 67,500
Partner 2 45% Est closing costs (14,850)
Partner 2 45% net proceeds 52,650
Equity:
Partner 1 10% Down 40,000
Partner 1 Loan payments made 45,000
Partner 1 Equity 85,000
Partner 2 Loan payments made 45,000
Partner 2 Equity 45,000
Total Partner 1 net proceeds plus equity = 149,350
Total Partner 2 net proceeds plus equity = 97,650
So which way is the "right" way to calculate each partner's profit? The co-tenancy agreement indicates profit will be calculated the 1st way. The operating agreement is a a pretty stock template only denoting the 45/55 split in capital contributions as an exhibit. Is there any precedent for calculating profit the 2nd way?
Answer
This is a prime example of why "stock template" operating agreements are not always the best. They don't always cover every situation and can sometimes lead to confusion. It is best to have specific language on the Operating Agreement that discusses exits, sales, and division of assets. With no other information to go on Scenario one is probably the way a business adviser would interpret the situation. The best action is to consult an contracts lawyer.
