Buying my own house with LLC to step us basis?

[Greg Stander]

I am in a situation where my ex-wife and I own a house jointly (and still live here). The house has appreciated about 500K so we can each get the capital gains tax exclusion if we sell the house (yes, we’ve lived here the last two years) and basically pay no capital gains.

However, I’d like to buy her out and turn it into a rental for a while (maybe just a few years). The problem is, if I just buy her out, I don’t get a stepped up basis. And then, if I sell, say a year or two later, it is now a rental and I get no exclusion at all so the entire 500K gain is taxable. There is no disadvantage to her either way as if we sell the house, we use the exclusion. If I buy her out, she pays no taxes. The point is, there is no reason she would take ‘less’ to make up for my taxes.

I was wondering if I could, instead, have an LLC purchase the entire house from both of us – giving us each the tax exclusion which would also step up the basis to the new value. Of course, I realize property taxes and such will go up (I'm in California so are taxes basically stay at the original purchase price level until re-sold) but I'll get more depreciation too.

But really, the real advantage is that if I decide to sell in the next few years (likely), I will have a stepped-up basis to start from. The questions are:

• -Is this legal and does it actually step up the basis as expected?
• -The LLC doesn't actually have enough cash to buy ‘me' out (but does for my wife) but I already own ½ the house. It just needs to have enough to pay her off and I can transfer the deed from my part into it. Is this OK and can I just report the sale as the full amount or something?
• -Or is this just crazy and there is a better solution?

Thanks,

Greg