Cons for selling our house to our LLC?

[Anita Parsa]

My husband and I are dipping our toes into rental real estate by renting out the family home that we've been in for over 22 years.

We own the home outright.  With 22 years of appreciation, we would be just under the limit to exclude all capital gains if we were to sell right now instead of rent. 

We own the home free and clear.  We have a 2 year lease with our first tenant starting soon.  We have a property manager, a low maintenance seeming tenant, and a house that's in pretty good shape.  In the ideal scenario, we picture keeping the property as a cash flowing asset forever and letting our kids deal with it after we die.

BUT, if that doesn't happen, and we decide to sell in 7 years or 10 years, I'm going to kick myself for losing out on the capital gains tax exclusion of $500k.  

Today I had a chat with the attorney who is setting up our LLC and putting the house into the LLC, etc, about the pros and cons of selling the house to the LLC as a way of capturing that gain and also helping maximize my depreciation calcuation. I'd love to get input from experienced people here on this idea.

I searched for this situation in the forums and found several discussions of selling to an LLC but not on point with my situation. Please be gentle; I'm new at this and it's pretty complex :)

Structure / Legal Details

- we'd establish market value through a combination of comps from local real estate agent and an appraisal

- attorney would establish all required "arms length" aspects including a mortgage at a minimum standard federal rate

- LLC would pay us back based on a standard promissory note over 30 yrs

Pros of selling to the LLC (I think)

- A sale now would be the only time we'd be able to take advantage of the cap gains exclusion on this house bc we won't qualify for the "live there 3 of 5 years" rule due to the timing of our lease and our last time of residence.  We don't intend to move back into this house.  And  if we did a 1031 exchange later, I think I'm correct that having this cost basis established at today's market value vs 2001's cost + improvements would serve me better in the 1031.

- The depreciation amount for my rental house would be maximized bc would be set at the selling price / current market value vs 2001 cost basis + improvements.

Cons of selling to LLC 

- Ongoing legal & tax paperwork that is more complex & potentially more expensive than if we kept ownership outside LLC

- ?

Thank you for any comments, questions or personal experiences with this situation.

Anita

[Dave Foster]

@Anita Parsa, You only have to live in the property for 2 out of the previous 5 years.  You would still have time after the two year lease to evaluate and decide if you wanted to sell at that point.