I'm trying to understand how to account for the following scenario.
Three partners purchase a somewhat dilapidated income property for $600K, each partner contributing one third. It requires significant work to prepare for leasing, totaling $120k.
One of the three partners contributes an additional $120k to the partnership, and expects to be repaid from the income stream after the property is leased. The $120k goes towards capital improvements that raise the value of the property to $720k. I see two ways of accounting for this:
- The $120k is a loan, and the first partner is made whole after withdrawing the entire $120k. Effectively the other two partners end up paying the entire cost of the upgrade.
- The cost of the upgrade represents a capital contribution and must be shared equally between the partners, so each partner's share is $40k. The first partner is made whole after being repaid $80k.
Which of these is correct?
If it's a loan, as if the partnership went to a bank, then each partner would end up having paid $40k out of income. The bank would walk away with a zero balance.
However, in the second case partner 1 walks away with a zero balance PLUS an extra $40k in equity, which the bank wouldn't get. Effectively the other two partners paid $60k each.